Cats and Dogs

A term that refers to stocks with poor fundamentals. In a raging bull market, many stocks with poor fundamentals, including cats and dogs rise in price.  An investor should pay close attention to his stocks, because though a stock with poor fundamentals can make gains at first, it is probably not sustainable.

It is somewhat ironic that, when an industry recovers from a downturn or recession, the worst stocks, or the cats and dogs in this case, actually make the largest recoveries.

Let’s say there is company A and company B. Company A is a strong company in the industry, for every $100 of goods sold, it makes $20. Company B is a laggard in the company, for every $100 of goods sold, it makes $3.  Now a recession or downturn hits and demand for the particular good falls. Assume its price falls $10 across the board(highly unlikely that the price fall would be uniform as each company’s product is probably unique) and Company A is now only making $10 per $100 of revenues, while Company B is actually losing money—losing $7 for every $100 in revenues.

Now suppose the industry heads into a recovery,  and prices for the product rise $10 again. Company A would make $20 again and Company B $3. Company A would experience a 100% rise in profits, while Company B would experience an infinite turn, as it swung from a large loss to a profit. Thus Company’s B stock would experience a large decline in value in the downturn and a huge rebound in the recovery.

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