As the pandemic-induced March market swoon and subsequent rebound prove, plenty of investors like the idea of catching fall knives.
Dancing with beaten names is alluring, but the persistent risk for investors is that stock picking with tattered equities is difficult and that stocks in this category are here for various reasons, few of which are positive.
Enter the Direxion Fallen Knifes ETF (NYSE:NIFE). NIFE, which debuted in June, tracks the Indxx US Fallen Knives Index. Companies with 12-month, excluding the most recent month, losses of 15% make the “short list” for possible inclusion in the index.
Why It's Important
Though it's still in its infancy, NIFE is off to an impressive start, returning nearly 13% since inception. Good timing helps. NIFE debuted at a time when there's still plenty of upside to be had for quality stocks that became fallen knives at the hands of the aforementioned first-quarter market slide. Additionally, NIFE makes the task of identifying these companies easier.
“The idea of falling – or fallen – knives is a commonly understood one, and the rules-based approach allows for a framework to capture the most attractive opportunities. The fund may provide investors with a distinctive approach to U.S. equities with a distinct exposure profile,” according to Direxion.
An important element in the pro-NIFE thesis is that the fund does the important legwork for investors. That being differentiating between bad stocks that became fallen knives for credible reasons and financially sound companies “suggesting that the security has potential for share price recovery in the future.”
Indeed, NIFE's roster includes plenty of healthy companies as the healthcare and technology sectors combine for over 76% of the fund's weight. Those are two of the highest quality, most cash-rich sectors in the S&P 500. Put another way, it's getting harder to consider Nvidia (NASDAQ:NVDA), NIFE's second-largest holding at a weight of 5.78%, a falling knife.
Speaking of quality and cash, NIFE components are scored on quality metrics, including current ratio, cash flow coverage ratio, and debt to equity.
Bottom line: NIFE has the potential to continue its winning ways because it's not including stocks simply because those names are beaten up. It's looking for names that may be beaten up too much and have the underlying fundamentals to support legitimate and lasting rebounds.