Everyone likes a bargain, but buying shares after big falls is not a good strategy. Certainly, some shares bounce back strongly after significant falls, but more often than not, that isn’t the case. The general trend is that underperforming shares tend to continue to lag the market for some time.
With this in mind, here are three beaten-down shares that I’m avoiding at the moment.
Dividend cut risk
First up is telecoms company Talktalk (LSE: TALK). The company’s share price has fallen by 19% over the past year, which compares unfavourably to the UK FTSE All-Share Index’s gain of 24%.
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Talktalk has struggled to shake off the damage caused by the high-profile hacking scandal in 2015, and in order to win back customers, management has decided to rebrand the business. Talktalk is returning to its challenger roots by focusing on delivering value for money for its customers and keeping prices down. Signs of success are beginning to show too, with its churn rate falling to less than half the levels seen last year.
But looking forward, Talktalk faces margin pressure from higher costs due to rising investment needs and hikes in BT Openreach wholesale charges. Because of Talktalk’s more limited size and its new Fixed Low Price Plans, the company seems be in a weaker position than its rivals.
Moreover, Talktalk’s dividend policy seems unsustainable as city analysts expect its dividend cover to fall short of 0.7x this year. This indicates a dividend cut is likely to take place soon, and the risk of this happening will likely continue to weigh on Talktalk’s share price.
Difficult trading
Defence supplier Cobham (LSE: COB) isn’t doing any better. The company’s share price fell by 15% today after yet another profit warning — its fifth in the past 12 months.
Cobham said it now expects underlying trading profit for 2016 to be £225m, which represents a further reduction of £20m from its January guidance of £245m. It’s also well below the estimate of £290m from only three months ago.
There’s mounting uncertainty about its troubled contract with Boeing’s KC-46 tanker programme, and there is growing concern that Cobham may need another equity raise before long.
“The balance sheet is clearly not strong enough to properly support the operations of the group,” the company said in its press release today.
Regulatory risks
Shares in CFD provider Plus500 (LSE: PLUS) have barely recovered since the FCA announced plans to clamp down on the contracts for difference market in December.
New regulations could pose a bigger challenge for Plus500 than its larger rivals as regulation tends to hit smaller firms the hardest. Proposed changes to make it more difficult for Plus500 to acquire new customers and restrictions on marketing would have a greater impact on the company as it has relatively high churn rates.
Shares in Plus500 currently trade at eight times forward earnings this year. That doesn’t seem too demanding, but given expectations that profits will fall sharply under the proposed new regulations, I’m avoiding its shares for now.
