After the VW emissions scandal, how can you guard against blue-chip stock collapses?
Shares in Volkswagen have collapsed, falling more than 38% since news of the emissions-fixing scandal broke last week. But if blue-chip stocks are supposed to be the safest investments, how can you protect yourself from such collapses? As a trader, how should you guard against the emergence of sudden market-moving news?
What have investors learned from the VW scandal?
The unthinkable has happened – Volkswagen’s sterling reputation has been tarnished and share prices have plunged. The world’s #1 selling automobile manufacturer has come under harsh criticism following a criminal scam intended to deceive the rules and regulations mandated by the US EPA.
VW has long trumpeted itself as an environmentally friendly automobile maker. The Clean Air Laws in the US are among the strictest in the world. For this reason, VW embarked on an aggressive marketing campaign to extol its virtues as a high-performance, fuel-efficient and environmentally friendly car maker.
It turns out that everyone has been hoodwinked. When driving tests were conducted, Volkswagen vehicles expelled 40 times more pollutants into the atmosphere from their exhausts than the US EPA allowed. The International Council on Clean Transportation conducted the independent tests and the conclusions were nothing short of scandalous.
According to industry analysts, Volkswagen had been deceiving the EPA for seven years. To add insult to injury, they refused to admit to the wrongdoing even when they were presented with the evidence. But the proof of the pudding is always in the numbers: VW shares immediately plunged 17% and the German automaker lost $15 billion in its market capitalisation. And the sell-off still continues.
Now the German car maker is attempting damage control with €6.5 billion set aside to deal with the problem. The number of vehicles affected by the scandal could be as high as 11 million and, while VW attempts to win back its credibility, investors will be finding plenty of value in a share price that is dropping faster than a roller coaster on its way down. On a positive note, the VW Group intimated that it does not accept violation of laws in any way whatsoever. The company is determined to win back the trust of customers the world over, and is willing to conduct transparent and credible checks to meet EPA standards.
That the problem is software-related could spell further disaster for VW. The EMS (Engine Management Software) is also installed on other diesel engine vehicles including Volkswagen Group vehicles. According to Volkswagen, the diesel engines comply fully with European Union regulations. But for VW the problems run deeper because the US government could impose punitive measures on the company to the tune of $18 billion. According to reports, VW may have to recall half a million Beetle, Golf and Jetta vehicles, as well as Audi A3 vehicles from 2009 onwards. This issue is particularly sensitive in the US where diesel emissions of nitrogen oxide are strictly monitored.
The vehicles that were independently tested by the West Virginia University included a 2013 Volkswagen Passat, a 2012 Volkswagen Jetta and the BMW X5 SUV. Only the BMW X5 SUV passed the emissions test while the others failed hopelessly. But the ruse was uncovered when the CARB and the EPA refused to green-light VW’s range of 2016 diesel models. Only then did VW explain how it was scamming testing agencies. Analysts called the tactic a defeat device in the software.
This sudden turnaround in Volkswagen’s fortunes, based on the sudden emergence of new information, leads to the inevitable question for traders and investors…
How to protect against blue-chip stock plunges?
Everyone is telling you to buy blue-chip stocks – these are the strongest performing companies in the FTSE 100 index, the Dow Jones and other leading indices around the world. They are reportedly less volatile, more stable and have high-yield potential over time. And besides, these household brands are really easy to identify and don’t require the services of expensive fund managers.
But when things go awry with blue-chip stocks, as they have with Volkswagen, how do you guard against plunging portfolios?
Blue-chip stocks may be less volatile than other stocks, but that is no excuse for taking your eye off the ball. Investment analysts can readily point to a list of (often scandal-led) blue-chip stock failures over the years, including Tesco, Kodak, Enron, BP in the Gulf of Mexico, Polly Peck, Woolworths, The Rover Group, London Brick Company, et al.
The list is extensive, and now that VW has been added to it, investors should not be surprised. Here are some of the things to look out for:
- Buyers must be cautious of Dividend Cover – any figure greater than 2 is an indication that the company can afford to keep making payments. But beware of figures lower than 2.
- Industries that are susceptible to high levels of regulation should be viewed with some caution. Firms may be subject to harmful changes in legislation, and liable to hefty fines when things go wrong.
- A Return on Capital Employed (ROCE) of less than 10% is a danger sign, but ROCE figures under 15% are also cause for concern.
- Individual shares are not the best way to invest – even with blue-chip stocks. The best way to invest is through funds with upwards of 150 to 200 stocks.
Clearly the best way to protect against individual blue-chip stock crashes is to diversify. By diversifying your investment portfolio you can benefit from the collective strengths of these top-performing companies even if a minority of them fail over time.
For more information, trading education and offers visit Intertrader.com
The content of this article is the personal opinion of the author and not Intertrader.com. The information and comments provided herein under no circumstances are to be considered an offer or solicitation to invest. Nothing herein should be construed as investment advice. The information provided is believed to be accurate at the date the information is produced.