Stocks performing badly? Don’t rush to sell them
Many investors decide to hold or sell an investment based on the price behaviour of the share; that may not be optimal
Renuka, a middle-aged professional, earns a decent sum. After making investments in fixed income securities like bank deposits and mutual funds, she moved to direct equity investment. She went through the financial journals and TV channels dedicated to equity market investments.
After purchasing some equity stocks, Renuka noticed some stocks were going up and some were going down. Though she had a time frame of one year to book profit, the volatility in the market made her nervous and she was always in a dilemma on whether to sell or hold any stock.
Renuka’s is not an isolated case. Almost all equity market investors face such a situation.
There is no shortage of financial literature about when to buy a stock, or on the selection of equity stocks. Broadly, it can be grouped under buying based on fundamentals or technical factors. Much of this literature provides some sort of guidance to the investing public and the investors do get a grip of these suggestions and implement the same.
You hold a stake in the enterprise
Most investors are confused about the right time and the right price at which to sell. They do not realise that when they buy a stock they are actually buying a part of a business. Since that realisation is not there, they are glued to the stock price everyday or every second during trading time, and get excited or perturbed by the price movements. After all, when one buys a house, he does not think about the market price of the property on an ongoing basis.
This does not mean investors should not monitor the performance of equity stocks. If they buy a stock based on fundamentals, then they must hold on to them for as long as the fundamentals do not change. Or until they find another stock with better fundamentals.
But when an investor buys simply based on ‘technical factors’, then the call has to be taken based on a technical analysis, which is primarily based on the price factor and volume of transaction.
Taking a decision to hold on to a stock or sell it can be challenging. There is no universal, one-size-fits-all strategy for selling a stock. In fact, it should be based on many factors including the investor’s risk bearing capacity, risk bearing willingness, time horizon, projected performance of the company, and so on.
The reason for selling a stock may be to adjust a portfolio or free up capital or book profit when the target price is reached or when there is a change in the fundamentals or when there is a technical call. One can hold the stocks if the market price in the future appears rewarding. One can estimate the future value of the stock and arrive at the present value by using a discount on the expected interest rate.
The future price depends on the future earnings of the company. This in turn depends on various fundamental factors like demand for products, cost advantage, pricing power, competition etc. These are difficult to predict and project for common investors.
But one can be sure about the factors that should not influence the decision to sell. Many investors decide to hold or sell an investment based on the price behaviour of the share. But that may not be optimal.
Let us see why.
Numbers that don’t count
Purchase price of the stock: One’s purchase price is the past and history. This is not going to decide the future price of the scrip. One has to forget the purchase price because it will clutter the thinking process to arrive at a decision to sell or hold based on future price expectation.
Price of stock at all-time high or 52-week high: Again, this is irrelevant to the decision. An all-time high or 52-week high does not mean that it cannot go up further or it will be a barrier. The high reached may be an aberration or may be based on fundamentals. Anyhow, this does not decide its future price.
Price of stock at all-time low or 52-week low: This is also irrelevant for similar reasons.
Difference between purchase price and market price as on date: Generally investors try to judge whether they are in profit or loss, and based on that, they decide on the further course of action. Most investors are averse to booking losses. They continue to hold hoping that they will get at least their purchase price. But future price has nothing to do with one’s purchase price or whether one is in profit or loss.
The only factor to be considered is the underlying business as on date and where its earnings and cash flows may increase in future.
As Ben Graham said: “In the short-run, the market is a voting machine — reflecting a voter-registration test that requires only money, not intelligence or emotional stability — but in the long-run, the market is a weighing machine.” Investors must understand that the stock market is not a casino but a medium of wealth creation through stocks.
So, what should you do when the stock falls?
When the market is falling down, your stock may follow suit. But, as we have seen in the past, the bourses will assimilate all the negatives in course of time and start looking up once again. Though one may not be able to suggest a time frame for such a reversal, one can be sure about its happening.
When one has made investment based on the fundamentals of the company, as long as there is no change in the fundamentals, one can safely hold the position, as ultimately the stock will be priced based on true intrinsic value and fundamentals.
India is an emerging market and it is expected to show the best GDP growth in the years to come. Hence, it is better to wait patiently by holding one’s position. One need not sell in panic.
On earlier occasions, when Foreign Institutional Investors (FIIs) pulled out, the market used to fall heavily. But on recent occasions we have witnessed that retail domestic investors are filling up the gap and taking long positions in the market, which has been recently acknowledged even by the Finance Minister. It is a fact that the participation of retail investors will stabilise the market and reduce volatility in the long run, which will help the market to rebound in the near future.
But investors must check the fundamentals of their holding and based on it decide whether to hold or sell. Companies with low or no debt can be attractive when there is inflation, which necessitates increase in interest rates. In the same way, the companies with pricing power to pass on the increased cost to consumers may also be attractive.
(The writer is a retired banker.)