What is this post about?
Retail investors invest in the stock market to make money. Sometimes they invest in stocks which give them good returns, and sometimes not. Due to various reasons, investors may discard a stock as a bad pick, and never look back at that stock. They may even start hating the stock, and comment on online forums and finance blogs advising other investors to dump this stock.
Why do some retail investors hate a stock? Because it caused them a loss? Because the company’s management did not fulfil their promise on revenue growth targets? Well, the reasons to hate a stock can be many. In this post, I will focus on the most common and wrong reasons to hate a stock. If one of these reasons is true for you, do give that stock a second fresh look.
Let’s get started.
Reason 1: Price goes down after you buy a stock
This is the most common reason to hate a stock. Buying a stock is often driven by stock recommendations on social media. Or by price targets given by fund houses such as ICICI securities, Kotak securities, Goldman Sachs, Jeffries etc. However, once retail investors buy a stock, the price starts falling. Sometimes, even after a week or a month, the investor is sitting in losses. The investor might think- “The price targets given by fund houses turned out to be false. The recommendations given by social media influencers turned out to be fake. I will forever stay away from this stock. I will suggest all my friends to stay away from this cursed stock as well.”
Example 1: Gland pharma is a newly listed company (listed in 2020), and is a contract manufacturer of injectables. Motilal Oswal (a reputed stock broker firm), gave a price recommendation of INR 3700 in May’22, when the stock was trading at INR 3096 (20% upside). However, from May’22, the stock has tanked to levels of INR 1700 as on 16th Dec 2022 (-45%).
How to evaluate good stocks even in bad situations?
Set Right Expectations
It is obvious to hate a stock which has given you loss. But not so fast. Stocks go up and down all the time. So set your expectations right. Expect a 30-40% loss from any stock in the short term (3 months to 1 year).
The second expectation you should have is when reading stock recommendations. No one can predict stock price movement. If stock price targets were true all the time, everyone can just follow these targets and make high returns. However, this is not the case. Stock market is a zero sum game. If you are making money, someone else is losing it.
Majority of price targets given by professional fund houses are not met. This does not mean that these target reports are not useful. They are useful in knowing more about the company. They help you understand if the company has positive sentiment around it. Apart from that, take the actual price target with a pinch salt, and add your research on top of it.
Go Back to Basics
When in doubt, go back to basics of evaluating a stock. Is the company run by good management? Does the company has a moat? Has the company delivered on its past promises? Is the future growth story of the company intact? If the answer to these questions is yes, then you may want to stick with the company, even in its bad times. A popular stock evaluation framework I use is GEMS (Growing Company, Efficient Operations, Good Management, available at Sale Price). Read more about the GEMS framework here.
Understand the Reason behind Price Decrease
Price increase or decrease almost always has a story behind it. Find that story. You can search online news, or listen to company’s conference calls to know more on this. If the reason behind price drop is uncontrollable, macro economic related, then it is ok to stick with the company. Overall, if the company is not faltering in its growth strategy, then there is nothing to worry about. You can actually use this opportunity to buy more shares of the company. However, if the dip is because of company specific reasons such as management rejig, compliance failures, fraud related investigations etc., then you are better off exiting the company.
Going back to the Gland Pharma example, its price decrease of 45% from May 2022 to Dec 2022 is driven by reducing sales of the company. This in turn is driven by raw material supplies. This is an external factor, and not company specific.
A company should de-risk itself by diversifying its sourcing, or being backward integrated. It remains to be seen if these raw material supplies constraints will ease up in coming quarters,. How will the company strategize its sourcing in the future to prevent a similar situation from happening again. As on Dec 2022, we do not know how the story of Gland Pharma will pan out. Hence new investors can stay at bay. Existing investors can wait and track developments instead of exiting in loss.
Reason 2: Less Returns than the Index
Many investors compare their stock investment returns with the index. This is also recommended. Comparing returns vs the stock market index gives you an idea whether your stock picks are working better than or worse off as compared to the index. The aim is to beat the index. If not, then a retail investor can simply invest in the index fund, and chill.
What happens when your investments consistently perform poorer than the index. You get frustrated. Your months or years of learning stock market investment is not reaping results. You run out of patience, and start putting the blame on the stocks you invested in. Something must have gone wrong with these stocks for them to perform poorer than the index.
Example: ITC is a monopoly stock in the cigarette sector in India. Apart from the cigarette sector, it is a leader in the Hotels segment, and has a fast growing FMCG business vertical as well. Despite this, ITC gave low returns from 2014 to 2018, of only 21% in 4 years. However, the Nifty 50 index gave 40% returns in the same time period, twice of what ITC gave. This was despite ITC’s topline (revenue) and bottom line (profit) growing consistently every year from 2014 to 2018.
How to evaluate a stock giving poorer returns than the index?
Compare with Sector Index
One should compare the returns of a stock with the industry sector index, and not with the overall market index. Example: Nifty 50 is the overall stock market index, with top 50 listed companies as part of it. However, these 50 companies are from multiple industry sectors, such as Banking & Finance, Metals, Infrastructure, IT, Oil & Gas etc.
We have industry sector indexes, such as Private Banking index, IT sector index, Metals Index, IT Index etc. One should compare a stock with these industry sector indexes for a closer performance comparison. If the stock is consistently performing poorer than the industry sector index, then it is a worrying sign. In this case, go back to basics, and re-evaluate the strength of the company using the GEMS framework.
Understand Up and Down Cycles
Each sector goes into some form of an up cycle and downcycle. Up cycles are marked by tailwinds, high revenue and earnings growth. Down cycles are marked by headwinds, stagnant or low revenue and earnings growth. These cycles typically last 1-3 years. Understanding these cycles will help you realize if the stock you invested in is in an up cycle, hence growing in price. Or the stock is in a down cycle, hence decreasing in price.
For example, in 2022, the Indian IT sector is in a down cycle due to recession in the west,. This has led to many tech giants such as Amazon, Adobe etc. reducing their new investments. However in 2022, the Indian Banking sector is in an up cycle, given the rising credit growth and interest rates by RBI.
Going back to the example of ITC, this stock did test investors’ patience for a long time, before giving a breakout in 2022. In 2022, ITC has given 54% in 2022, beating the Nifty index and the overall Cigarette and FMCG index. Investing gurus are not entirely wrong when they ‘Patience is the name of the game’ (game here refers to stock market investment).
Reason 3: Reducing Dividends from the Stock
Some investors invest to get a side fixed income. In the world of equities, this translates to investing in a dividend paying company. However, a company can decrease the dividends it pays out, or worse, stop paying dividends altogether. This might upset the set of investors who want a fixed income from their stock investments.
Example: Indiamart Intermesh, India’s largest listed B2B commerce player. Indiamart has decreased its dividend in 2022 vs 2021 by 92%. This might upset investors looking forward for a dividend payment similar to 2021.
How to evaluate a company with decreasing dividends?
Investors should note that reducing dividend, or stopping dividend payment is not a bad sign. In fact, it can be a good sign. Top companies around the world such as Amazon, Google, do not pay any dividends. There are many valid reasons for decreasing dividend payout. Some of these are below.
Investing in R&D
Some companies have to continuously do research and development in order to pave the path for future growth. Example: Pharma and API companies have to research to develop new drugs, molecules, and efficient processes of producing these drugs. These companies might increase R&D expense to strengthen their future product pipeline, and hence might decrease or stop giving dividends.
Investing in Capex
Companies expand by building new manufacturing facilities, or expanding existing manufacturing facilities. This is typically true for companies who manufacture end products, such as Automobile, Wires & Cables etc. These expansions are funded by internally accrued free cash flow, or by debt. Debt is not a preferred choice to fund capex, and therefore companies might choose to reduce dividends and divert that money to facilities expansion.
Acquisitions
A company can grow inorganically by acquiring other companies. These acquisitions help the company expand into new geography, or new verticals of services which have synergy with the services offered by the parent company. Going back to the example of Indiamart, it has acquired multiple companies post its IPO in 2019. This might be a reason for a temporary decrease in its dividend payout in 2022.
In summary, look at the reason for decreasing dividends of a company. If there are valid reasons behind the dividend decrease, which spur the future growth of the company, then it is ok. It means that the company is pursuing its growth strategy, and you will get returns in terms of stock price increase over time.
If you absolutely need a fixed income, then you should go for stocks which have higher probability of paying dividends. These are government owned companies, such as Coal India, Indian Oil Corporation etc. These public companies pay dividends to meet the government’s expenses. Hence they will most likely be regular in paying out dividends in the future as well. Do note that capital appreciation in government owned companies might not be much or limited. It is not advisable to only invest in stocks based on dividend yield.
Parting Thoughts
We all invest with a goal in mind. As long as the goal is reasonable, and our expectations from the stock market returns are realistic, one should be good. The golden rule to make money from the stock market is to be patient, and utilize the extreme mood swings of the market between pessimism and optimism to the fullest.
The next time you start disliking a stock, dig deeper in your feelings. Which expectation of yours from the stock was not met? What is the reason behind the expectation? Does your research of the basics of the company still show good future growth? Are other companies in the same industry sector also facing a similar situation? If yes, then hold on to the stock, and you will likely reap returns in the future.
What is one stock you absolutely hate, and why? Do share in the comments below.
Happy Investing !
‘India ka time aa gaya hai’ – Sir Rakesh Jhunjhunwala
