Just three months ago, shares of Kirkland's (NASDAQ:KIRK) fell 17% to nearly $10/share. At that price, the stock was brought up as a potential stock idea as its P/E was only 6 after subtracting out the company's net cash position. Last week, however, the shares traded up close to $16/share, resulting in a very strong return over a very short period. The lesson for investors is simple: Catch the falling knife, and sell it to Mr. Market once it's no longer falling.
There is a multitude of research that suggests that stocks that underperform the market tend to outperform the market in subsequent periods. Despite this, the mainstream media and analysts continually advise against buying a stock that is falling. This is terrible advice. Panic-selling can often create just the opportunity the value investor is waiting for.
Of course, this doesn't mean one should buy just any falling knife. All investments must be studied and vetted carefully. A company's current financial position and future earnings power must always be considered relative to its asking price. But "falling knives" should be welcomed as potential opportunities, and not situations to be avoided.
Near $16/share, Kirkland's stock is no longer the steal it was just three months ago. The company's P/E (now near 10) faces upward pressure as same-store sales are declining in the high single-digits. However, the company's financial position remains strong, as Kirkland's has $60 million of cash against no balance sheet debt. Nevertheless, the company likely trades a lot closer to fair value than it did when it was identified as a potential value opportunity. (And even if it is still slightly undervalued, it is likely better to be approximately right than precisely wrong.) This offers value investors a chance to get out and deploy their capital towards the next opportunity.
Disclosure: No position