During times of distress, it’s a common observation that many investors start booking losses and exit from under performing stocks.
While Portfolio re-alignment is a must and one should ensure that he/she is holding right set of stocks, however exiting from a stock just because it has either declined in value since one’s purchase or been an under performer does not help in securing good returns in equity investments. It could rather turn out to be the most costly decision as far as returns are concerned.
One should have a clear rationale behind both buying and selling a stock. It’s always better to check out the following few points before you take the decision:
- Why did you in first place buy the stock? If you were advised by your financialÂ adviser, make sure you ask why is he now suggesting you to sell a stock?
- Has anything fundamentally changed since then or is it just the negative outlook for the sector which will change as the time will pass?
- If it’s just the negative outlook for the sector then every stock good or bad gets hammered, so check out how is the company you invested in faring in critical times?
- Have you found a new potential investment which holds more value than your existingÂ under-performingÂ one or is it that you are just fed up watching the stock down?
We feel checking the above few points will help you take a more rationale decision rather than a casual decision of selling without any thought process.
Let’s discuss the above viewpoint with an example:
Take for instance stocks from sectors like Infrastructure, Capital goods, financial services, etc. You all must be aware that stocks from the mentioned sectors have been beaten down badly, many to the extent of 60-70%.
Now there are two investors, let’s call then A & B.
Investor A invested in a good company from the infrastructure space (Let’s call it XYZ Ltd) , on being advised by his financial advisor some 8 months back. Over the time the Global economy took a nasty turn and domestically inflation surged thus leading to a relentless hike in interest rates by RBI.
Now the stock XYZ Ltd is down by 40% and has thus grossly underperformed both the indices and the other holdings in his portfolio. The stock is down not because company has performed badly, rather the ever increasing interest rates hit the spends on infrastructure and the whole analyst community which was once gung ho about infrastructure sector has turned negative causing damage across the sector.
Investor A, out of his frustration sells the stock at a loss of 40%.
Investor B didn’t invest in the same company XYZ Ltd when his fellow friend invested 8 months back, however he is now really interested in making investments in that particular company. Here are some of the positives he is looking at:
- The stock which was available at Rs 100 (used for ease of calculation) 8 months back is now available at Rs 60. It may go down to 50, however the downside is limited while the upside is huge (One gets insanely low valuations only during times of pessimism. It is difficult to invest or be optimistic at times, but One-two years down the line, this will look like a reasonable or good investment opportunity.)
- The spending on infrastructure has slowed for sure, however there remains no doubt that once the interest rate cycle peaks and starts moving down, the investments will pick up and there will be a positive outlook for the sector (the more the delay, more violent will be the spending)
- The company could stand strong during critical times. It may emerge stronger with higher market share (the weaker players are already out of business as they could not sustain the downturn) once the environment improves.
- The company can witness both an earnings expansion (lower interest outgo in lower interest rate regime) and a re-rating to pre-negative outlook multiples thus delivering the highest returns over the next 1-2 years.
So, for the same company there could be two different opinions. While Investor A was right initially in buying the stock, he commits a blunder by selling at the time of desperation and maximum pessimism.
When one is contemplating selling an underperforming stock, it is always better to change the frame of reference. Try and consider the same stock the other way round i.e. what would you have done had you been not holding the stock. If on changing the frame of reference, you find value in the stock and would consider buying then why sell it in the original place.
Flashback to 2008-09 and you will be able to correlate the above scenario with Auto and Auto ancillary stocks. The stocks were down and out because of the reported bankruptcy of US auto majors like General Motors and the overall slowdown in the sector. Those who sold out in the midst of pessimistic outlook and bought stocks of other companies missed out some of the most lucrative gains as the Auto and Auto ancillary stocks witnessed the major bull run on the back of domestic spend on two and four wheeler purchases.
The idea basically is to make sure one has head at the right place while making equity related investment decisions.
– Ekansh Mittal [email@example.com]