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What is a Fire Sale?

2017-05-06T08:40:00+00:00

The term 'Fire Sale' is included in the Corporate Finance edition of the Financial Dictionary. Get yours now on amazon in ebook or paperback format. Read more here...

A fire sale is a phrase with a variety of interesting meanings. The term originated in reference to the reduced sales price for goods which were damaged in a fire of a shop or business. Since then, it has come to refer to any event which forces a business to move its assets or inventory goods for prices that are substantially discounted. The reason the business would be forced to engage in such a practice is because they are in a bind through some type of serious and often-times fatal financial distress.

Where financial markets are concerned, the phrase fire sale also refers to any securities (stocks, bonds, or other financial instruments and investments) which trade at a deep discount to their intrinsic value. This could occur in extended and painful bear market phases in the equities markets.

There are a number of examples which help to clarify the several different meanings of this concept of a fire sale. Take a department store as a prime example. When the department store company has to close its doors because of a bankruptcy event, the store might offer such a sale. In this specific scenario, the department store will offer its inventory of goods at what would normally be considered ridiculously low prices.

They do this so that they can liquidate the entirety of their in stock inventory. Since the store is closing up for good, they must be rid of each item in the store’s inventory. The only means of effectively accomplishing this lies in providing prices so drastically reduced that bargain hunters will be lured in to purchase the stock. When the prices offered on the merchandise are so good as to be irresistible, then this qualifies as a fire sale.

Where securities are concerned, there are always examples of a fire sale of a given stock issue. Any time a particular equity security sells for far less than the value it is perceived to be worth, this qualifies as such a sale. Look at a clear example to consider. When the Dow Jones Industrial Average cratered by a full thousand points within the day, Proctor and Gamble (ticker symbol PG) crashed and burned by a quarter of its value on a temporary basis. This led investors and analysts to declare that there had been a real fire sale on the share of Proctor and Gamble that particular day. In this particular scenario, the phrase for this kind of a sale signifies that the asset in question possesses significantly greater value than the price for which its owner is suddenly willing to sell it.

These stock or bond securities which appear to be offered for this dramatic sale often provide an appealing risk to reward payoff possibility for the types of buyers known as value investors. This is because the asset is not likely to experience significantly further deterioration in valuation, yet the profit potential to the upside could possible prove to be impressive. The truth is that there is no single set of metrics for valuing whether or not a particular stock is actually selling for a ridiculously low price. One factor that many analysts can agree on is that if a stock is being valued at multiple year lows in the price, then it is generally considered to be a huge bargain.

As an example, stocks which are trading continuously for 14 times earning multiples would likely be fire sales when they trade for a far lower multiple of earnings of a mere seven. For this to be true in all scenarios though, the fundamentals for the given company and its stock must remain more or less unchanged. In other words, they can not simply have deteriorated appreciably in the meanwhile.

The term 'Fire Sale' is included in the Corporate Finance edition of the Financial Dictionary. You can get your copy on amazon in Kindle or Paperback version. See more details here.