Activist investors can help you decide whether to buy a stock or not. Here's why!
Every Wednesday, we publish articles focusing on investment tips and strategies in the hopes of helping our readers achieve true financial freedom. For today’s article, we’ll highlight an investing insight that can serve as a guide for your future moves in the market. Are you ready to learn about today’s topic? Keep reading below to know more!
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Activist investors can help you decide whether to buy a stock or not. Here's why! In May 2023, hedge fund Engaged Capital announced its activist stake in beloved burger chain Shake Shack. The immensely popular restaurant chain is known for its delicious burgers and other menu offerings. That said, why did Engaged Capital take a sizable position in Shake Shack? To answer that question, it’s important to understand what activist investing is first. Activist investing involves the acquisition of a significant stake in a publicly traded company to influence how it is run. Investors who take an “activist” position in a company usually do this to change how a firm is run for the purpose of attaining better shareholder value and financial performance. Achieving those objectives may come in the form of advising management, forcing the sale of a firm, or replacing a business’ board of directors. In the case of Engaged Capital, it doesn’t invest in companies and wait for shares to rise. Instead, the hedge fund works with firms to improve their businesses, unlocking the stock's value faster. Circling back to Shake Shack, the fast food chain saw a massive dip in its Uniform return on assets (ROA) in 2020, which continued to persist until this year. Due to this massive decline in ROA, Wall Street analysts and the rest of the market think that Shake Shack will continue to struggle, with the belief that the company’s Uniform ROA will hover around 0% for the next 2 years. If Wall Street analysts and the rest of the market are right about their expectations, then this would mean a decline in the value of Shake Shack’s shares.
Given everything discussed above, why would Engaged Capital invest in a company that the market expects to struggle? The answer is simple: The first step to stock picking isn’t deciding what you think the company can do since it’s about understanding what the market expects that firm to do and deciding if you agree. In this scenario, it’s clear that Engaged Capital doesn’t agree with the rest of the market and its expectations for Shake Shack. Due to this, it’s reasonable to assume that the hedge fund thinks it can get Shake Shack back on track and push the company toward higher earnings, giving its stock the chance to beat investor expectations. To achieve that goal, Engaged Capital worked with the fast food chain to improve its digital presence and cut down on costs. Furthermore, Professor Joel Litman, Chairman and CEO of Valens Research and Chief Investment Strategist of Altimetry Financial Research suspect that the hedge fund is focusing its efforts towards helping Shake Shack attain comparable profitability among its peers. For those who don’t know, Shake Shack’s business model is a bit of an oddity compared to its rivals because around half of its stores are fully owned and the other half are franchises. On the other hand, the fast food chain’s competitors either fully own their stores or operate on a franchising business model. While either ownership model can be successful, Professor Litman said he wouldn’t be surprised if Engaged Capital pushed Shake Shack to choose one ownership model moving forward. This is because if the fast food chain starts to operate like its peers, it can significantly exceed market expectations. — As mentioned above, the key to picking stocks is understanding a market’s expectations about a specific company and deciding whether you agree with the assessment or not. In the case of Engaged Capital, it saw an investment opportunity in Shake Shack because the market was undervaluing the burger chain. By taking an activist stake in the Shake Shack, Engaged Capital wants to help the company beat market expectations and receive higher returns as a result. Remember: Activist investors can significantly impact the trajectory of underperforming companies. By keeping track of the companies they’re investing in, you’ll be able to spot opportunities that will benefit the performance of your investment portfolio. Hope you’ve found this week’s insights interesting and helpful. Are you familiar with Murphy’s law? Learn more about why you should always prepare for the worst in investing in next week’s article! |
