Re-rating companies

One of the comments that get's thrown around a bit is when a company is "re-rated" by the marketplace. The theory goes that as a company prospects become clearer the investment analysts decides it's too cheap and starts to pile in boosting it's SP price to theoretically more appropriate levels.

My query is "How quickly should this happen ?" It seems to me that a number of stocks with seemingly excellent prospects are still under priced. (Of course if one is strong in the belief that the stock is badly underrated this just makes for excellent buying opportunities.)

What do other members think ? Is the general investment community just too slow or too cautious or does it realistically take a long time and absolute certainty for stocks to be re rated ? Any past or present examples to help make the case ?

Re: Re rating companies

In a Bear market the investment community is over cautious, and in a Bull market over optimistic, ILU is a good example of a big stock that's under gone a massive re-rating over the last 10 months....the SP didn't start to take off until production was well under way at there new mine and increased world demand and rising prices for there products was well established.

Re: Re rating companies

Imo it takes a while, technical traders won't jump on until the price has already showed a bullish pattern (catch 22 a little), so it's usually down to the old boring fundamentalists to shove the price up a little. The market also heavily discounts risk, especially in the smaller caps of the ASX.

Once the risk either dissipates or lessens, fundamentalists usually step in and shove the price up, which makes the techies take notice and begin buying, so on and so on. Usually some "concrete" evidence is needed for this, such as a quarterly cashflow report, or sometimes all that's needed is confirmation of the desired result (plugging in the gas pipes, or the first boatload of coal out of port etc).

Often the market will misprice something for many months and then suddenly and violently rerate it. So you've always got to be patient with underpriced assets on the ASX, when you sell out might be just before the big rerate .

I pretty much only invest/trade companies that are being re-rated or have a high potential of re-rating.

IMO The underlying drivers of re-ratings come from the fundamentals of a company. There's two key components to this; "Risk" and "Time".

As more news about a company comes to light it typically reduces the risk of the investment by increasing the likelihood of the re-rating fundamental event to occur (ie: contract signing, technology being proven, oil/gas found in well etc.) As the risk reduces the market is more confident to re-rate the company towards its intrinsic value.

Some news can be well known however the re-rating event won't occur for another 2-5 years. Accordingly the time/value of money will come into play, the potential of another GFC, the company may need to raise further cash etc. etc. so all of those things mean the company doesn't jump straight to the re-rated price. There is a "time risk" involved where things can still go wrong.

There's also a third component (not fundamental) and that's market awareness. If no-one is following or knows about a company then it is unlikely to get re-rated. Despite what some claim the markets are not efficient and good stocks take a while for enough people with enough $$$ to notice them. This is where the tech. analysts tend to jump on the bandwagon.

It's my belief that the secret to extra-ordinary returns is identifying companies that:
- Have not been correctly risk adjusted by the market
- Have a very high re-rating potential in the near term
- Doesn't have much market awareness (small/mid caps, little chatter on forums etc.)

I have typically found that as the risk decreases the market awareness tends to increase (although not always, they're the best opportunities), but can be sluggish. This gives an ideal time to "load up" and enjoy the ride as others "discover" the hidden value in the company.

So, to answer your question "How quickly should this happen?"... well it depends. An Oil & Gas company may re-rate in a single day because of results from a single drill hole. A technology company may slowly be re-rated over a couple of years as independent analysis of the technology is verified, the technology is proven on a large scale, a commercialisation partner is secured, funding is secured for expansion etc. etc.

Each company is different and the challenge is to have an in depth level of knowledge of your company. This allows you to identify the "re-rating price drivers" of the company and get an idea of the key milestones and the time it will take for these to occur.

Hope that helped somewhat... but it's just my opinion of course