As many seasoned investors have learned, media sentiment is rarely congruent with the big-picture financial severity of any story line. For instance, United Airlines shareholders had a minor mini panic attack when video surfaced showing security officers forcibly dragging an elderly man from his seat because the flight was overbooked. Within hours, people had taken to social media to express their outrage and threaten to boycott the airline.
The startling footage and media backlash quickly overwhelmed the public. A naïve investor may have assumed that the negative publicity and criticism would lead investors to sour on United’s stock. In reality, there was a selloff and rally that left the stock essentially where it was before the incident. It appeared that investors shrugged off the incident and the handful of influencers who publicly boycotted the airline later backed off their stance when United adjusted their over-booking policies and procedures.
Looking back on the ordeal, it was completely meaningless in terms of its stock price influence.
Predicting a Stock Price Plunge
Some United Airlines investors might’ve misinterpreted this event’s impact on United’s stock price. Those individuals might have predicted that this scandal could deteriorate their long position in United.
They overreacted to United’s shocking treatment of a passenger and assumed the market would punish United for its terrible behavior. The thing is, the market didn’t react to the frenzy of negative activity around the airline the way some investors would have expected. That’s not because the market condones United’s mistreatment of passengers. Instead, the market asks itself whether this rare event puts in jeopardy the characteristics that had previously made United viable.
Investors who panicked and bailed on United’s stock probably failed to ask themselves if United suddenly lost what it takes to make it in the airline industry. These investors could have save themselves some trouble if they had asked themselves the following questions:
- What are the conditions and attributes that make United successful?
- Will this event significantly alter those conditions or attributes in a meaningful, lasting way?
One Incident vs. Over 140 Million Passengers
United Airlines is successful because of their extremely economical operations. This has allowed them to establish a consistent presence with stable market share. To be blunt though, they’ve never been known for treating their customers very well. In fact, there have always been stories in circulation describing United’s sub-par customer service.
United is a stable airline because of price, convenience, and consistency. Each year, United serves over 143 million passengers. Although it was a deplorable incident, this random occurrence with one victim didn’t alter United’s strengths that have made the airline what it is today. Certainly not enough to make a dent in the airline’s stock.
While their public image has taken a beating, United’s poor service will remain poor, their airfare will remain competitive, and the airline will continue to be a big player in the industry.
If you take a look at United’s 10-K, you can gather that their business model summary is mostly silent on their customer service improvements. This omission becomes especially noticeable when compared to a Jet Blue Airways 10-K.
Most of United’s stated achievements have little if anything to do with any measurable customer service improvements. Instead, quarterly reports focus on technological advances, changes they are making to their fleet, and business class related data.
Long story short, United’s niche was never strong customer service. Therefore, if I held a long position with them before this event, the unfortunate storyline wouldn’t alter my investment plan. This approach is supported by my two-step analysis.
A Scandal that Would Change My Outlook on a Company
You’ve probably heard about the Volkswagen scandal involving their so-called “clean diesel engines.” In the fall of 2015, it was officially announced that Volkswagen’s clean diesel models could pass emissions testing only while they were in test mode. When the vehicles were actually in use, they produced pollution levels were roughly 40 times greater than in test mode.
Volkswagen fooled the public by installing a system that would limit testable emissions released while the car wasn’t moving. That system would then turn off as soon as the steering wheel was engaged. This fraud was repeatedly covered up during the investigative rigmarole and ultimately resulted in a record $30 billion in penalties for Volkswagen.
The circumstances surrounding the Volkswagen scandal suggest that the automobile company could be in for a not so bright future. Starting in 2009, the clean diesel campaign hit the United States hard and left an incredible impression on American consumers. They claimed they had created a car that is more powerful, more fun, and most importantly environmentally friendly. Endless Volkswagen commercials perpetuated the false claims of newly achieved air conscious quality.
From 2009 to 2013, American sales nearly doubled. That would be the highest American market share percentage since 1971.
Adding to the lack of good faith, Volkswagen is presently taking every opportunity to circumvent their responsibility for continuing to excessively pollute the environment. While they faced steep financial consequences in the US, they were almost untouched in Europe. Volkswagen has strategically placed manufacturing facilities in neighboring countries desperate for job creating movements. In return, most of these countries turn a blind eye to the unsavory operations.
In 2009, roughly six million passenger and commercial vehicles were being produced globally. Automobile production spiked up to more than10 million units at the height of the clean diesel craze in 2014. In the years following the scandal, production has remained around 10 million units, but profits have taken a massive hit.
Now, let’s apply that two-step process to determine whether Volkswagen’s stock price will take a prolonged hit after their scandal.
Question #1: What are the conditions and attributes that make this company successful?
Volkswagen had been a historically trusted brand for about 75 years. They consistently marketed to consumers that their product is “the people’s car” starting with the iconic beetle. In the ’50s, Volkswagen was associated with the regeneration of Europe after the second world war. Moving into the late 1900s and the 21st century, reliability and trust were at the forefront of their brand image. “If only everything was as reliable as a Volkswagen” and “The Car” perpetuated the concept that their brand was the culmination of design inspired by consumer desires.
Question #2: Will this event significantly alter those conditions or attributes in a meaningful, lasting way?
In my view, falsified conditions and attributes were responsible for heightened public opinion of Volkswagen. It appears that Volkswagen will likely revert back to their pre-2006 level of effectiveness, but will have to go about increasing their efficiency while dealing with the added label of being a “dishonest company.”
Though Volkswagen had been a trusted brand for 70-plus years, today’s consumers are a new generation. This new generation will not be won over by proofs of company philosophy that predated their birth. As the clean diesel scandal has existed without full resolution for roughly a decade the sample size of corrupt activity is large enough that a new brand association has been created. The new brand association could very well have a long lasting effect that should concern even the most devoted buy-and-hold long term investor.
In conclusion, this firmly engrained reputation of distrust, paired with the possibility of further financial consequence in Europe, would justify a changed outlook on stock position.
A Few Final Thoughts
Mature companies have unique characteristics that contribute to their success. Over extended periods of time, it is inevitable that events will transpire that cast the company in a bad light. Sometimes the negativity will only be temporary; other times, the negativity is prolonged.
Before reacting to a scandal, take a look at why the company is successful. Ask yourself if the scandal interferes with those key characteristics. Overreactions to meaningless events can actually price discounts into stock prices. But these discounts only become possible due to hoards of investors who panic and fail to properly analyze the situation. Don’t be that investor.