Many long-standing companies at one time or another have faced critical, headline-making challenges that have threatened the company's ability to operate and make profits. There are various reasons for the challenges, from external forces - like the Tylenol scares that hit Johnson & Johnson (NYSE:JNJ) in 1982 when seven people died from taking capsules that had been poisoned with cyanide - to internal forces like Merck's (NYSE:MRK) non-acknowledgement/disclosure of the risks associated with Vioxx. Despite product issues such as recalls and lawsuits, some companies weather the storm and emerge faster and stronger, while others are virtually destroyed.

So what characteristics make a company more susceptible to failure through difficult times? Read on as we take a look at some historical corporate disasters.

Tutorial: Fundamental Analysis

Four Companies, Four Different Stock Reactions

1. Tylenol and the Speedy Recovery
In the past 30 years, there have been several examples of negative headlines that have plagued companies and threatened their survival. Some companies have emerged from these scandals stronger than ever, while others have floundered, sometimes for years. Johnson & Johnson, the maker of the well-known over-the-counter pain reliever Tylenol, faced one of its biggest challenges in 1982. After the deaths of several people who took poisoned Tylenol were announced on September 29, 1982, the stock took a split-adjusted nosedive of 17%. However, as it became known that the company was not responsible for the cyanide-laced pills and the poisonings occurred at the store level, the stock was able to recover its pre-headline price of $2.95 within 43 days of the scandal, and was on its way up to $3.20 by January Of 1983 - a return of 31% from the low point after the negative headlines hit. Why is this? In part, it's because J&J handled the scandal well; by issuing press releases and remaining visible during the investigation, the company maintained investor and consumer confidence. (For more on what happens to a stock during a scandal, see Playing The Sleuth In A Scandal Stock.)

Figure 1: JNJ September 1982-February 1983. A) Day before tampering case; B) Low price is hit and volume jumps; C) Price returns to recent highs (43 days)
Source: Yahoo! Finance

2. Merck's Hard-Fought Battle Back
(NYSE:MRK), another drug maker, faced similar challenges in 2004 when one of its biggest selling drugs, Vioxx, was found to increase the risk of heart attacks. Unlike Johnson & Johnson, Merck allegedly knew about the risks but did not disclose them during the clinical trials or after the drug was on the market. Prior to this, Merck had a good reputation in the market as being one of the strongest research and development drug companies, so investors were shocked by the news. The company's stock fell from $45 to $33 on the day the news broke, a drop of 36%. After further investigations uncovered that the company may have known about the risks and tried to cover them up, the stock continued to drop, finally landing at its low of $26 almost 40 days later.

Figure 2: MRK August 2004 - December 2005; A) Initial fall; B) Second fall
Source: Yahoo! Finance

Although many in the news media speculated that the company would not survive this type of negative publicity or the flood of lawsuits that were filed, the company did survive and the stock finally returned to, and surpassed, its former high price in January of 2007. After many initial missteps, Merck eventually took several actions to allay investors' fears. First the CEO was replaced, second, the company vigorously fought the lawsuits (which are traditionally difficult to prove) and last, the company introduced new products to the market by focusing on research and development and making some key acquisitions. Despite these efforts, it took more than two years for the stock to return to its former highs. (For more on pharmaceutical stocks, see Stocks On Drugs: What It Takes To Get High.)

3. ExxonMobil's Great Escape
ExxonMobil (NYSE:XOM) is one of the world's largest oil exploration and production companies. On March 24, 1989, one of its tankers, the Exxon Valdez, hit a reef in Alaska and spilled millions of gallons of crude oil. This disaster was caused by a variety of factors, including human error and poor judgment, poor maintenance of the ship's radar system and possibly an inadequate number of crew members, according a 1990 report by the National Transportation and Safety Board. As a result of its negligence, ExxonMobil was ordered by a federal court to pay $5 billion in punitive damages (which was reduced to $2.5 billion), and $287 million in actual damages. Interestingly, the stock barely reacted to the news of the spill, or the initial fine, and the disaster resulted in only a 4% loss in stock price after the largest fine in history was announced.

Figure 3: XOM 189 - 1995; A) Dip on announcment of spill; B) $5B fine announced.
Source: Yahoo! Finance

The reason this stock reacted very minimally to the announcement of the spill and the fine may be a result of how oil stocks are priced. Oil stock prices are based on perceived supply and demand. The spill caused a decrease in available supply, while demand remained at steady levels. Therefore, the expected result would have been an increase in the price of a barrel of oil. The $5 billion fine was the highest fine ever levied against a company. However, the market assumed that this fine would be reduced and would be tied up in the court system for many years, so investors did not focus on its immediate impact to profitability. (Learn more in Understanding Oil Industry Terminology.)

4. Toyota's Decceleration
Toyota Motor Corporation (NYSE:TM), a leading car manufacturer, was once known to the market as the maker of reliable, well-made cars. On November 2, 2009, January 21 and January 28, 2010, the company recalled many of its car models due to sticking accelerators, which caused unintended acceleration. At first, the November recall had no effect on Toyota's stock because it was small and thought to be due to a problem with Toyota's floor mats. But as the recall widened and evidence of deaths suggested there were other issues, the January recalls caused Toyota's stock to drop from $90 to $72 over a 15-day period, a loss of 20%.

Figure 4: TM October 2009 - March 2010; A) Initial recall; B) Expanded recall with further investigations
Source: Yahoo! Finance

Six months after the recall, Toyota's stock still had not recovered. The 20% loss and the slow recovery can be attributed to the fact that consumers purchase cars that are affordable and safe. When consumers lose confidence in an automaker, sales typically suffer.

The Traits of a Suvivor
There are many examples of companies that failed to survive a challenge and no longer exist, but most of these are due to fraud or illegal activity (Enron), or excessive risk taking (Bear Stearns and Lehman Brothers). However, there are several characteristics that are common to companies that faced major challenges and survived. First, the larger capitalized the company, the better-prepared it is to weather a financial storm and gain access to external funding should the need arise. Second, companies with long histories and strong reputations tend to have investors' support over the long term, as well as access to external funds. Third, the cause of the challenge determines whether the company recovers quickly or slowly. An external cause typically results in a short-term impact to the stock, while an internal cause can have a long-term impact.

The Bottom Line
When examining a stock scandal, determining whether the cause is internal or external and examining the company's moves to mitigate any effects on its stock price are key. Investors may attempt to sell the stock on the news and then analyze the situation later. However, this type of timing is very difficult to execute because once the news breaks, institutional investors have generally already made a decision to sell and the small investor may end up selling at the bottom. (See Enron's Collapse: The Fall Of A Wall Street Darling, and Case Study: The Collapse of Lehman Brothers.)

Related Articles
  1. Economics

    Investing Opportunities as Central Banks Diverge

    After the Paris attacks investors are focusing on central bank policy and its potential for divergence: tightened by the Fed while the ECB pursues easing.
  2. Stock Analysis

    The Biggest Risks of Investing in Pfizer Stock

    Learn the biggest potential risks that may affect the price of Pfizer's stock, complete with a fundamental analysis and review of other external factors.
  3. Professionals

    4 Must Watch Films and Documentaries for Accountants

    Learn how these must-watch movies for accountants teach about the importance of ethics in a world driven by greed and financial power.
  4. Markets

    PEG Ratio Nails Down Value Stocks

    Learn how this simple calculation can help you determine a stock's earnings potential.
  5. Investing

    What’s the Difference Between Duration & Maturity?

    We look at the meaning of two terms that often get confused, duration and maturity, to set the record straight.
  6. Fundamental Analysis

    Buy Penny Stocks Using the Wisdom of Peter Lynch

    Are penny stocks any better than playing penny slots in Vegas? What if you used the fundamental analysis principles of Peter Lynch to pick penny stocks?
  7. Fundamental Analysis

    Are Amazon Profits Here to Stay?

    Amazon is starting to look like a steadily profitable company. Is this really the case? Should investors even be hoping for profitability?
  8. Investing Basics

    4 Iconic Financial Companies That No Longer Exist

    Learn how poor management, frauds, scandals or mergers wiped out some of the most recognizable brands in the finance industry in the United States.
  9. Entrepreneurship

    10 Ways to Be a Successful Entrepreneur

    Are you hoping to launch your own business and work for yourself? If so, here are the top 10 tips for entrepreneurs.
  10. Personal Finance

    Wal-Mart vs. Target: Which One Is A Bigger Threat To Amazon?

    Walmart and Target both revealed multi-year plans to grow their businesses. Which of these two retailers is the biggest threat to Amazon?
  1. What does low working capital say about a company's financial prospects?

    When a company has low working capital, it can mean one of two things. In most cases, low working capital means the business ... Read Full Answer >>
  2. Do nonprofit organizations have working capital?

    Nonprofit organizations continuously face debate over how much money they bring in that is kept in reserve. These financial ... Read Full Answer >>
  3. Can a company's working capital turnover ratio be negative?

    A company's working capital turnover ratio can be negative when a company's current liabilities exceed its current assets. ... Read Full Answer >>
  4. Does working capital include stock?

    A certain portion of a company’s working capital is generally composed of earnings; however, current short-term assets that ... Read Full Answer >>
  5. Does working capital measure liquidity?

    Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
  6. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  2. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  3. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  4. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  5. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
  6. Monetary Policy

    Monetary policy is the actions of a central bank, currency board or other regulatory committee that determine the size and ...
Trading Center