Over the last decade investors have enjoyed staggering annualized gains, 13% for the S&P 500 to be precise. For that to continue in the next decade the S&P would have to trade over the 15,000 level and (even assuming consistent earnings growth), the S&P 500 components would need to trade at PE multiples of 35.
Those unlikely scenarios should call to mind the period between 2000 and 2012 when the S&P produced no gains.
Where can investors find stocks that can drive stronger returns even if the market goes nowhere? One source is to find out-of-favor companies that have attracted the attention of activist investors. Activists focus on turning underperforming stocks into winners. These highly-specialized investors take ownership positions in laggards, then engage with the company leadership to make meaningful positive changes to the company’s strategy, management and profitability.
Companies have two basic resources: revenues and assets. Revenues are produced by selling something of value and are a source of cash for the company. Assuming that the value proposition is worthwhile and is producing reasonably stable revenues (activist investors tend to avoid companies with weakening revenues), activists can drive changes to how the company uses the incoming cash.
Is the cash being efficiently allocated to drive more revenues and value to new and potential customers? Are manufacturing or services being produced efficiently enough? Is the company keeping its overhead costs under control? How productive are the dollars being re-invested in keeping offerings relevant and sufficiently profitable?
Activists also focus on assets. The most important asset for most companies is its talent base. Is the leadership providing sufficiently focused strategic and tactical direction and oversight? Are the right people in place to execute the company’s strategy? Activists look at other assets, like real estate, brands and business lines to evaluate whether their value is being fully realized or if they might be worth more if owned by someone else.
If properly executed, an activist-led turnarounds can be remarkably successful. In 2017, activist investor Trian Partners exerted intense pressure on Procter & Gamble (PG), leading the previously moribund shares to drive higher in a surge that continues today.
2 Beaten-Down Stocks Targeted by Activist Investors
Two current activist investor campaigns look interesting to us:
Stock #1: Peloton (PTON)
Founded in 2012 by a Barnes & Noble executive, Peloton (PTON) went from a pandemic star to an unprofitable company in disarray. If the post-pandemic hangover was Peloton’s only problem, it would likely be in as good a shape as many of its product’s diligent riders. But, like many accidental winners, Peloton was poorly managed, leaving the company with excessive weight, poor direction and dashed hopes.
Little-known activist investor Blackwells Capital, which holds just under 5% of Peloton’s shares, wrote a scathing letter in late January 2022 (found here) highlighting the “multiple leadership failures” by the CEO/founder, John Foley. The activist successfully catalyzed Foley’s departure. The arrival of the highly regarded Barry McCarthy on February 9 brings exceptional subscription-tech capabilities developed at Netflix and Spotify.
McCarthy graciously described Peloton’s key problem to the Wall Street Journal: “The Covid bubble was a great thing. It was a marketing campaign the company otherwise couldn’t have afforded… (but Peloton) … built out a cost structure as if Covid was the new normal.”
We see a tremendously valuable brand in Peloton, backed by its nearly 3 million subscribers that help generate almost $4 billion in revenues. With steadfast activist pressure and new leadership, shareholders in PTON stock could be well-rewarded after what likely will be a difficult turnaround.
Stock #2: Harley-Davidson (HOG)
Maker of the iconic motorcycles, Harley-Davidson (HOG) has struggled for years as its targeted customer demographic has aged. A turnaround effort led by a new CEO in 2015 precipitated a bloated array of inventory and new products that eroded the brand’s value and the company’s profits. While a better strategy that re-polishes Harley’s brand value, led by impressive new CEO Jochen Zeitz (March 2020), is making progress, the planned sale of its LiveWire electric motorcycle business to a SPAC hasn’t been met with wide shareholder support, nor has its management, board structure or operations.
Activist investor H Partners recently raised its stake in Harley to 8% and has reached an agreement to join the company’s board of directors. H Partners is perhaps best known for its campaign against mattress maker Tempur Sealy (TPX) in 2015, which led to strong shareholder gains. The turnaround at Harley-Davidson will likely grind forward but should gain a lot more traction with an activist overseeing the drivers.
Have you ever bought a stock because activist investors got involved? How did it turn out? Tell us about your hits and misses in the comments below.