Usually, when a stock gets hit harder than anybody expected on some bad news, caution is advised. The traders and institutions that effectively control the price of stock may be many things, but they are not stupid. If it looks like Wall Street is begging you to buy then it should start alarm bells ringing in your head. That doesn’t mean, however, that things aren’t ever mispriced. Of course sometimes they are, and overreaction to bad news is the most common cause of that.
“Bad news” doesn’t do justice to the earnings reported by Genworth Financial (GNW) last week, at least at first glance. Expectations were for a profit of around $0.16 per share, but instead the company reported a loss of $0.64. A miss as big as that, obviously, doesn’t come without some kind of extraordinary item, and that was the case here. Genworth acknowledged that legacy Long Term Care (LTC) policies were even more of a problem than previously thought and included a total charge of $698 million to account for likely losses from them. Nearly $700 million is nothing to be sneezed at for a company whose market cap before the announcement was around 10 times that.
Most, therefore, found it unsurprising that the stock dropped from above $14 to around $8 when the news came. Indeed, if all of that charge had been a surprise, then that would be a reasonable reaction, but it wasn’t. Genworth had already said that they would have to take a charge for these policies at some point and, while the actual number was around double what was expected, it is reasonable to assume that the expected charge was already priced in at some point. Despite that, the additional $300 million or so in charges along with a subsequent downgrade of Genworth’s debt by S&P, caused around $3 billion to be wiped off of the company’s valuation
This has led many to conclude that Genworth is a steal at these lower prices and this is a classic market overreaction. That would usually be the initial reaction of value seekers, among which I count myself, but in this case I believe caution is warranted.
What gives me pause is the old saying “fool me once shame on you…” The thing is this is not the first time that Genworth has seen a major line of business move, somewhat unexpectedly, to a huge loss. The company went public in 2003, at which time it was one of the leaders in the field of mortgage insurance. It isn’t hard to imagine how that turned out come 2008.
Still, GNW managed to avoid bankruptcy and came out swinging. They began to dominate the Long Term Care insurance market. That particular market drew some controversy at around that time, with allegations of high pressure sales techniques fairly commonplace. I was surprised, then, when I was working as a financial advisor at a major Wall Street firm to find that the two colleagues who I regarded as the most focused on their clients were both big advocates of LTC. Their logic was simple. LTC policies were, in both of their opinions, seriously mis-priced. They believed that the potential benefit to their clients given rising healthcare costs and longer life expectancy far outweighed the cost of premiums. Genworth’s charge last week would suggest that my erstwhile colleagues were right.
In the short term it could be that GNW will bounce off of that $8 level, as yesterday’s trading would suggest. It could, but over the long term it is hard for investors to trust a company that has essentially made the same mistake twice. Oscar Wilde once wrote that “To lose one parent may be regarded as misfortune; to lose both looks like carelessness.” The admittedly over-sized reaction to last week’s huge write off would suggest that Wall Street no longer regard Genworth as just unfortunate and retail investors would do well to take heed.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.