Thursday, February 28, 2013

Risk of holding vs. selling

Digest this! The risk in holding a stock that can virtually go down to zero is lesser than the risk of selling a winner too early. I realized this when Rakesh ran a few numbers to me. He had invested in Suzlon and Ultratech cements in the December 2008. Suzlon ran down from its 2008 highs of 62 to 25 now and Rakesh lost 60% of his investment. He had also bought Ultratech cements at 366 at the same time but sold it 2 months later after it appreciated by 20% to Rs. 439. He displayed a very normal behavior of holding on to the loosing stock but selling a winner. He holds the suzlon stock even now which is quoting at around 25 unable to accept the loss. He is hoping it will regain its original purchase price and he could avert a loss.
The biggest folly that leads to investing failure is not about holding on to a looser, but the selling off a winner. On one hand Rakesh held on to Suzlon hoping some day he will be able to pare the loss, on the other hand he sold Ultratech cement after it appreciated a meager 20%. Imagine a different scenario: Rakesh had held on to both the stocks until now, and that he had invested a similar amount of Rs. 1 lakh in each of them, his Rs. 2 lakhs investment would have now have become Rs. Rs 5.60 lakhs.  (1 lakh invested in suzlon would now be Rs 40,000 while Rs 1 lakh invested in Ultratech would have become Rs 5.4 Lakhs). This is a return of (cagr) 26% pa over 4 years. This is better than inflation. Imagine you virtually held on to a looser that has dented your pride, yet your action of holding on to a gainer would have more than compensated for the losses.
Rakesh was influenced by analyst’s definition of cyclical stocks and sold the cement stock expecting a glut in the industry to hamper growth prospects of Ultratech. And he reasoned the he could buy it cheaper later. The market is filled with very knowledgeable people who can define every situation and put a reason and logic to everything they have to say. The best time to sell a stock is 'never' as long as the company shows predictable earnings growth over long term.
Short term fluctuation must be ignored as long as the company is run by trusted management and the business has long term growth prospects. The risk of selling a winner far outweighs the risk of holding on to a looser. Hence it is wiser to hold and be proven wrong. A stock can only get to zero on the downside but technically there is no limit to how high it can go. Do not get swayed by stereotype definition of when to buy, when to sell. Experts can christen their style and call them such as earning or growth generator, contra strategy, special situations, mutlibagger ideas etc. These are traps for a small investor. Invest for the long term in companies managed by trusted people, who have displayed legendary commitments, where the industry has long term prospects and businesses have an irreplaceable value, provided you buy them cheap. Rakesh should have continued to hold his Ultratech cements, business that are subject to low rate of change. Cement is a mundane product that everyone needs subject to slow rate of change, as the legendary investor said, change is the enemy of investor.
 People will always buy cooker, under garments, financial services, cement, loans unless something terribly goes wrong. There is always the risk of unknown; we could face a period of prolonged recession. Risks are real, depressions are friends of investors. If you get a chance, buy distressed businesses in a distressed industry. Eventually markets will catch up with the true value of the business.