It makes good sense to avoid companies that are in the middle of intense governmental or regulatory scrutiny because the tide could turn either way for thems.
And so whether it's a generic drugmaker such as Teva Pharmaceutical Industries or an oil company such as BP PLC, shares of firms at the center of government probes can continue struggling long after the investigation is finished and punishments are delivered.
In the same way, Fiat Chrysler (FCAU - Get Report) and Renault (RNLSY) are now both uncertain investments after becoming the subject of emissions fraud investigations. While they may both look like bargains after their recent selloffs, there's no way to ascertain if a bottom has been hit. Also it's unclear whether investors will regain the same confidence in the companies as they did before the investigation.
The fact is, stocks such as these add headline risk to one's portfolio. Every rumor floating in the wind or slam piece written by a burned analyst has the risk of triggering further selloffs. Mistakes made by the company's management become magnified and victories are merely expected.
Shares of Fiat Chrysler dropped 14% following a Bloomberg report stating that the company is under criminal investigation for false reporting of its vehicle emissions.
Volkswagen faced emissions fraud charges in 2015. In January 2017, six Volkswagen executives pleaded guilty to criminal wrongdoing in cheating its diesel emissions compliance results. The company has agreed to pay $4.3 billion in penalties related to the government investigation. Overall, Volkswagen's costs in relation to the emissions scandal, including settlements from lawsuits from car owners, have reached $20 billion in the U.S., The New York Times said.
For Fiat, investors are justified in their fear that the company might be engaged in the same wrongdoing. Currently, Fiat's shares trade at a cheap forward price-to-earnings ratio of 5. The average for automakers is 8.
Before news of the Fiat investigation broke, the stock had staged a strong rally in the previous couple of months. Investors should remain cautious of buying on the dip because the investigation into the company has only just gotten under way.
France also officially launched an investigation into Renault on suspicion of emissions fraud, with three judges assigned to the case since last Thursday. In November, the French government had initiated the probe into whether Renault was engaged in criminal emissions fraud.
This makes Renault the third major European carmaker accused of emissions fraud. And the international community has made clear its intolerance for fraud connected to global carbon emissions.
At a forward price-to-earnings ratio of 6.4, shares of Renault look cheap but are also risky at this point. A lot could happen as the investigation unfolds, and investors are best advised to steer clear.
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