18 Apr 2020 by Pradeep U
Equity Investing; Why it is Important to Exit Stocks Which Have Lost Their Fundamentals?

It is a well-documented fact that, stock markets never move in a linear path. Neither do the stock prices of companies listed on stock markets.

There are ups and downs in earnings of companies every quarter depending on various factors such as sales, competition and demand for the products, regulatory changes, scenario in the global markets etc. to name a few.

I often come across investors who prefer holding on to stocks which have done well in the past, but have now lost their steam due to erosion in their fundamentals. One of the best examples of this is the stock of Yes Bank, which was once considered as a best stock to buy for long term in the Indian stock market.

However, post the erosion of the fundamentals of the stock, it became a falling knife trapping many retail investors who confused low prices with cheap valuations. Read more about it here.

Why it is important to exit those stocks which have lost their fundamentals?

Before we proceed further with an answer to this, I wish to share a small Zen story.

Two monks, one senior and a junior were travelling together when they reached the banks of a river where the current was quite strong. As they prepared to wade the water to reach the other side, they heard a woman asking for help to cross the river. She was a beautiful young woman who was afraid of the strong undercurrent in the water.

The monks looked at each other as they were strict bachelors who had taken vows not to touch women. Without saying a word, the senior monk picks up the lady and carries her on his back to the other side of the river. The lady thanks him and continues on her journey.

Surprised and speechless by this act, the junior monk too crosses over and reach over to the other side of the river. As both the monks continue on their journey, a couple of hours pass without a word between them.

Finally, after five hours, the junior monk questions the senior monk “How could you carry that woman on your shoulders, as we are not permitted to touch women as monks?”

The senior monk looked at him and replied, “Son, I left her on the other side of the river, five hours ago, why are you still carrying her in your mind?”

This simple but effective Zen story offers a beautiful message about letting go of the past and living in the present.

In your stock market investment portfolio too, it becomes essential to exit those businesses where the fundamentals have eroded.

To better understand this, let’s take a look at the example of HEG, once pegged as the best stock for investment on the D-street. From a high of Rs. 4,349 on 22nd Nov 2018, the stock is currently trading at around Rs. 670 turning an investment of Rs. 1,00,000 on the former date to just Rs. 15,406 in less than 17 months.

So, what went wrong for the stock of HEG?

HEG manufactures graphite electrodes which are used to melt scrap in electric arc furnaces to produce new steel.

Global slowdown triggered by the US-China trade war resulted in a decrease in demand for steel demand which in turn affected the demand for electrodes. Removal of antidumping duties on graphite electrodes imported from China by India led to an increase in imports.

I have used the above example just to give you an idea of how changes in the fundamentals of business (strong Chinese competition & change in demand in this case) can affect the valuations of a business adversely, reflecting in a fall in its share prices too.

However, erosions of fundamentals of any company could also happen due to numerous other reasons such as financial misappropriation, incompetent management, faulty succession planning, unprecedented increase in debt, changes in regulations etc.

Values of a business are built over time, one step at a time. However, one misadventure or mismanagement can also ruin them overnight.

Retail stock market investors who indulge in DIY investing or hearsay-based investing are often unaware of such changes in the fundamentals of a business. Such investors often make the crucial mistake of misjudging falling stock prices for cheap valuations.

Professional expertise of an equity advisory service makes a huge difference

When you avail the expert services of an equity advisory service, their research team keeps a constant track of any events which can affect the fundamentals of business, and if required may recommend exiting a business.

At the same time, an equity advisory service can also provide you with adequate rebalancing strategies. This is imperative so that your wealth creation goals remain on track.

Research & Ranking is a leading equity advisory service in India, with an in-house team of research analysts who have a collective experience of several years. With a combined employee strength of over 150 professionals and four office across Mumbai, Thane, Delhi and Bengaluru, we are well-placed to provide you the best equity advisory service which can help you achieve your financial goals.

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