Tuesday, 24 Oct 2017

Selling Stocks at the Right Time Is As Important As Buying Good Ones..!!

201709Jan

Is investing in equities only about buying good stocks? Let us recall some blockbusters of yesteryears— Jubilant Foods, Just Dial, DLF, Wockhardt, Financial Technologies, BHEL, SAIL, GMR, Kingfisher, Idea, Airtel and Satyam. Not only Indian companies, let us also recall some global bluechips such as Kodak, Blackberry and Nokia. How have these stocks performed in recent years?

Their price performances have not been up to the mark. In fact, most of them have underperformed for several years. The lesson is simple: while buying good stocks is certainly a critical part of investing, taking exit calls at the opportune time is also important. When and how does one take an exit call?

If we look at the above and some other underperforming examples, a number of scenarios emerge when one has to take an exit call.

The erosion of cash flow visibility is one of the prime reasons for the under performance of any business. If the business conditions change and the business is not able to generate cash flows in an expected time frame, then it would be very difficult to get returns from such business models. In the Indian context, over the past few years, some of the companies that own infrastructure assets have fallen in this category resulting in a sharp underperformance.

A sharp drop in genuine demand for a product or service is another reason for underperformance. Real estate is one sector where the demand pattern over the years has changed from users to investors. Also, the structure of the sector has emerged in such a way that the affordability of the product for genuine users came under question (possibly due to flow of unaccounted money). This resulted in non-sustainability of these businesses and sharply negative returns from this sector.

Removal of unrealistic subsidies in the business models is the other reason which leads to underperformance from such sectors and stocks. In India, some of the sectors which benefitted initially from such subsidies included metals and telecom. When these businesses were made to pay the actual cost for their raw materials (ores and spectrum), their profitability suddenly dipped, resulting in sharp underperformance.

Increased competition and inability to continue to have pricing power in any industry also leads to underperformance. Airlines (also, telecom) sector will fall in this category. Since the aviation industry does not have any control on higher crude prices and due to over-competition, airlines find it difficult to pass on the costs in entirety to passengers.

The other scenarios in which taking a sell decision will become very important are cases of technological obsolescence (Blackberry), end of product life cycle (Kodak), loss of competitive edge ( Just Dial) and business factors going out of control (which seems to be the case with Indian IT industry currently, though things may change in due course).

But the most important reason to sell a stock is if one finds that the promoters or management have questionable intentions. If the management is seen as not being minority shareholder friendly, one should immediately exit from such stocks (of course, fighting such managements could also be a way out).

For many investors, valuation also becomes a reason to exit a stock. However, for any sustainably good business, over-valuation cannot be a reason to exit. Valuation is a function of multiple factors and will keep going up or down. A good performing business will overcome the cycles of over and undervaluation to give returns to the shareholders. Classic examples here are the pharma, consumer and banking businesses.

Abhimanyu, the mythological character from the Mahabharata , knew how to enter the chakravyuh but what was more important was how to get out of it. Investing in good businesses is just one part of investing. When to exit is an equally important part.

 

 

By Kunj Bansal, ED & CIO (Equities), Centrum Wealth Management

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