Cut Losses Not Your Ties With Markets
A lot of people we meet these days are suffering from the ‘ostrich-effect’—a phenomenon in behavioural finance wherein investors panic in the face of negative news and go into financial hiding, just like ostriches, who are believed to bury their heads in the sand to avoid danger.
If you have been inflicted, it’s time to face reality and stop hiding. Get constructive…bite the bullet and revisit and review your stock holdings.
It could be the best thing you do for the health and safety of your portfolio!!
We’re here to help with some handy stock-reviewing tips…
Stocks fall largely on account of any (or all) of the following factors:
1. Worse than expected performance of global/domestic economy
2. Poor market sentiment
3. Sector-specific issues
4. Company specific factors
Cyclicality stemming from the performance of the economy
First off, you need to analyse if anything has changed fundamentally for the economy and whether that is driving bellwether indices to witness a bearish phase. It’s possible that with changing economic conditions, a company’s prospects too may undergo a sea change. In such a case, you need to be absolutely sure that the growth-levers of the company are still intact.
For instance, Indian steel manufacturers have been under the weather, thanks to the poor global economic outlook and trade war tensions between two of the world’s large economies—the US and China. While it’s affected Indian steel manufacturers negatively, some companies have taken a bigger knock due to company-specific factors, such as pricey acquisitions and mounting debts.
Consider these aspects too while analyzing the impact of cyclicality on your portfolio.
A fine line between cyclical fall and structural downturn
Like steel, auto is another cyclical sector. Hence, investors are not only holding onto some marquee auto stocks but are also averaging prices by buying more of them on dips.
As you may know, auto sales jumped in the post-demonetisation phase due to cheaper finance and better product offerings. Car ownership aspirations have been the key growth driver for auto sales, at least in the passenger vehicle segment all these years. Industry experts have now started questioning whether the aspirations of car-buyers changed.
India’s finance minister has also blamed the slowdown in the Indian auto sector on the popularity of ride-hailing.
Nonetheless, Electric Vehicle (EV) adoption and the implementation of BS-VI norms hint at structural changes in the auto industry. Are such disruptions creating new leaders and displacing established ones? Anybody’s guess.
Hence, price falls in stocks belonging to sectors undergoing structural changes must be observed with great caution. Don’t assume they will recover with the recovery in the sector.
If you are holding an auto company which may find it difficult to grow its profits in the changing environment, it’s stock price may not rebound quickly, or may not even in the worst case. Under such a scenario, it’s better to book a loss and move on to greener pastures.
At times, companies operating in the same sector face similar challenges. For instance, pharma companies selling generic drugs in the US markets have been facing the pressure of price erosion. Moreover, a few companies have faced the wrath of the US Food and Drug Administration (USFDA) for non-compliance.
These challenges are reflected in the poor performance of Indian pharma companies with large exports to the US. Will all of the rebound, once drug prices stabilize? Well, that depends on company strengths, compliance track record and the product pipeline.
Sectoral trends play a crucial role in returns you generate on your portfolio.
The table below suggests that if you invested in metals during FY11 and FY12, going by their impressive past performance, you would have burned your fingers in the next 5 years since then.
Similarly, if you ignored FMCG stocks in 2010, based on the relative underperformance of the past, you would have missed the bus.
Sector rotations and their effects…
Tough market conditions separate the boys from the men. When businesses are down, only a handful of companies can absorb shocks. Others end up weakening their competitive position or amassing a lot of debt to stay afloat.
Usually, any reading of net debt to EBITDA over3X-4X is considered as a red flag. At the end of FY19, 66 companies had a Net Debt to EBITDA ratio of over 3X.
Furthermore, over the last 5 financial years, 36 companies of (BSE 500) have witnessed some worsening in their Net Debt to Earnings Before Interest Tax and Depreciation and Amortization (EBITDA) ratio. And 18 of these have seen a jump of over 50% in their Net Debt to EBITDA ratio.
This ratio suggests how many years the company will repay its debts through profits earned through a business.
Did you know?
Over the last 8 years, Nifty’s 3-year CAGR return hasn’t been negative (on a yearly rolling basis) even once. However, 67 companies (of BSE 500)have generated negative 3-year CAGR in 3 years over the same observation period. And 9 companies have yielded negative3-year CAGR in7 of the last 8 years. This suggests that not all stocks rise or fall with the markets. And some stocks don’t generate positive returns for a prolonged time period after they fall.
Note: If any stock in your portfolio has fallen more than 50%-60% in the current context; ensure its growth levers are intact before averaging it.
Plan of action
- Identify reasons for the fall in stock prices—don’t mind admitting mistakes and selling them if there’s no recovery in sight
- Don’t just uproot losers, identify potential winners and buy them following the squirrel approach (of accumulating in small quantities)
- Take professional help if required
- Review your portfolio in both bull and bear phases
So, the next time you feel like burying your head in the investment sands, remember our words: “Don’t be afraid of bears—they help you test the quality of your portfolio.”
We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that: We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.