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Volkswagen AG: It's Too Early to Wade in

By Alex Dumortier, CFA - Sep 22, 2015 at 4:42PM

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Shares of Volkswagen are already down 34% as an emissions cheating scandal unfolds. They could well go lower still.

With copper hitting a three-week low and oil down by more than 1% on Tuesday, concerns about a global economic slowdown spilled over into the U.S. stock market. The Dow Jones Industrial Average (^DJI 0.03%) and the S&P 500 (^GSPC 0.01%) lost 1.1% and 1.2%, respectively, on the day. That's a performance that Volkswagen AG shareholders would have been delighted with, as the developing emissions cheating crisis battered the stock to the tune of a 16.8% decline, compounding yesterday's 17.1% loss.


Volkswagen CEO Martin Winterkorn. Source: Volkswagen Sweden. Re-published under a Creative Commons license.

For value-driven investors, a corporate crisis can beget opportunity, as existing shareholders sell now and ask questions later. That selling pressure can cause the company's stock to overshoot on the downside, pushing it below intrinsic value. That could happen to German automaker Volkswagen, which has admitted to installing a "defeat device" on 11 million of its cars in order to beat emission tests.

Two trading days into the scandal, and the stock is off nearly 34%. How much further could it fall?

As the Lex column notes in this morning's Financial Times:

Including recalls and compensation, [research firm Sanford C. Bernstein] estimates a low-end $2bn fine would take [4 euros] off the share price, while a top-of-the-range $18bn fine would cost [35 euros] per share. So [Monday's] price fall, of [30 euros], looks steep but not wildly irrational.

That was before today's bloodletting brought the cumulative two-day loss to 52.50 euros. That figure still doesn't prove we've entered the realm of irrationality: Bernstein's estimate covers only the U.S.

What does historical precedent tells us? The following table looks at the short- and long-term share price performance of two companies following major crises:

Company/ Crisis

Maximum Stock Price Decline, From Start of Crisis

Maximum Stock Price Decline, From 52-Week High

Cumulative 5-Year Outperformance* (Underperformance) Relative to Benchmark Index, From Crisis Low

Union Carbide** /
Bhopal gas tragedy (Dec. 1984)

(30.4%)

(49.6%)

+314.5%

(Benchmark: S&P 500)

BP plc /
Deepwater Horizon oil spill (April 2010)

(53.8%)

(53.8%)

+21.3%

(Benchmark: S&P Global 1200 Energy)

Volkswagen /
Emissions testing scandal (Sept. 2015)

(33.6%)

(55.1%)

?

*On a price return basis. Source: Author's calculations, based on data from Deutsch Börse Xetra, Dow Chemical, S&P Dow Jones Indices, and the London Stock Exchange. **Union Carbide was acquired by Dow Chemical, effective Feb. 6, 1991.

Strictly on the basis of this table, then, it would appear that betting on a recovery in a company's share price following a crisis is a good proposition, as shares of BP and Union Carbide outperformed over the next five years.

There are two major caveats: First, the outperformance figures assume that you can time the low in the stock price (you can't), and second, a sample of two is hardly definitive.

One metric is likely to be more robust: the length of time between the crisis first breaking and the stock price finding its low. In the case of Union Carbide, it took 70 days for the stock to bottom; for BP, just 15. The Volkswagen story is only in its first week (it broke last Friday).

While the Bhopal tragedy and the Deepwater Horizon spill were both events of extraordinary complexity in terms of their implications for the companies at fault, it took BP shares less than a quarter of the time that Union Carbide's required before hitting rock bottom.

That's consistent with the notion that the stock market has become more efficient over the past 25 years. Has it become more efficient since 2010? Probably not (or not much, at any rate.)

This two-day rout has already inflicted a lot of pain on Volkswagen shareholders, but there may be a bit of downhill still to go on this drive.

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Dow Jones Industrial Average (Price Return) Stock Quote
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