4 Dos And Don'ts About Companies With Lawsuits Attached

By Reyna Gobel
August 21, 2013

When Quant Advisor CEO Richard Dude used to research companies to invest in, the first thing he would do was google the company name and the word "lawsuit." If a lawsuit came up, he'd nix the idea of investment. His reasoning?  He didn't have the time to research what the lawsuit was about and the financial and business impact if the lawsuit was lost. He wasn't interested, nor had the time, to learn the causes or likely outcomes.

But sometimes, you still want to invest in a company, despite a pending lawsuit, because they're about to make the next big drug discovery. You could also already own stock in a company and then a lawsuit is filed.

In either situation, there are do's and don'ts Dude recommends that casual investors should follow.

Don't... Panic -- Unless Necessary
For a larger company, a lawsuit may not be a big deal. By the time you have bought the stock, or thought about selling, the stock price has already reflected the news of the lawsuit.

A small company could be wiped out by a lawsuit. Read about the lawsuit on newsfeeds such as Reuters and Bloomberg. Is it about a patent of their best product, for example? Companies such as drug companies and technology companies live and die based on the news that's reported on them.
 
Don't... Expect To Find Out The Dollar Amount
Early reports won't speculate what the settlement could be if the case is lost. The only amounts you can find are actual settlement costs and legal costs already paid. To find costs already paid, you'd have to review company's 10K financial document on SEC.gov.

Do... Beware Of Fraud Charges
Allegations of fraud can even take down a big company. For instance, if there are allegations of fraud against a chief executive, you should be wary of investing in the company.  This is one of the few events that is almost universally bad for business.

Do... Know Why You're Investing In The Company
If you're investing in a company with a pending lawsuit, you're taking a risk. How much do you believe that the company will recover from the lawsuit or investigation? Also, can you afford to lose the money you're risking? If not, you may be better off investing elsewhere.

The Investing Answer: Instead of buying one company you feel may be on top of the next big trend, invest the money in a portfolio of stocks that addresses the same issue. When a client recently came to Dude wanting to invest in a business dealing with health-care data collections, he recommended a portfolio of more than 20 health-care companies with solutions to data collection issues. The diversification strategy reduces risk associated with investing in stocks from smaller companies that may not have the proven record and revenue streams to handle the unknown such as potential lawsuits. He says it's best to invest in 20 to 100 companies tackling the societal or business problem you feel needs to be solved. As with most investments, hedge your bets by diversifying investments.