What to do when your favourite stock crashes?

Apr 23, 2012

In this issue:
» Per second billing to remain
» Reliance does not make money from oil?
» Gold loans curbed due to risk concentration - RBI
» Global crisis not yet over - China
» ...and more!

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Investing is all about doing your homework. You read up on a company, study its fundamentals, understand its business and then buy it when valuations are right. And if you have done your homework right, you can sit back and watch the show. In the long run you are bound to make money and earn handsome returns. But what happens when this favourite stock of yours comes crashing down? Well, most investors tend to skip a heartbeat when that happens. And the big question that haunts them is what should I do now? Should I sell the stock and book losses? Or should I hold on to it like I had initially planned?

The answers to these questions are to go back to your homework. The key is to study what went wrong. The sudden crash can be a result of either of the two things. The first is a one-off event like quarterly numbers, rupee movement, etc. These are not permanent events but the stock markets tend to react sharply to them. If the event is not permanent, then the impact on the stock should not be permanent either. Hence no cause for worry. Your long term view should remain.

The second is a more serious problem. And that is a change in the fundamentals of the company. This could be the result of change in company policies, acquisitions or business sell offs, change in government regulations, etc. In all, events that are more permanent in nature and hence impacting the overall fundamentals of the company. If the fundamentals of the company have changed and are no longer in line with your previous estimates, then there is only one course of action that remains. And that is to get rid of the stock and book losses.

So the bottom line still remains the same. Whether there is a crash or a boom in the stock price, always go back to the basics. If the fundamental strength of the company is intact, such crashes should be viewed as an opportunity to reduce your cost of purchase, i.e., buy more of the stock. If fundamentals are no longer the same, then it is time to get rid of your favourite stock.

What do you do when your favourite stock crashes? Share your comments with us or post your views on our Facebook page / Google+ page.

 Chart of the day
To boost the investments in the bond market, the Finance Ministry has asked the Reserve Bank of India to open a US$ 10 bn window. This window is to allow foreign individuals to invest in the corporate bonds. As per the finance ministry, this would boost the foreign investments in the bond markets as the foreign investors would be able to earn higher returns on Indian debt as compared to what they earn in US or Europe. This does come as good news for the underdeveloped bond market in the country. However, foreign investors would prefer to wait and see the tax implications of such investments. For the scheme to be successful, the foreign individual investors should be taxed at the same rate as the foreign institutional investors (FIIs). Currently the FIIs can invest up to US$ 15 bn in government securities and US$ 20 bn in corporate bonds. However, FIIs have been pulling their money out of the Indian markets since the start of the global crisis.

Source: Economic Times
* Data till April 22, 2012

Recently, the Telecom Regulatory Authority of India (TRAI) issued certain mandates for the telecom players. All service providers have to compulsorily offer in each service area at least one 'per second billing' tariff plan for both postpaid and prepaid subscribers. They would have the liberty to offer alternative tariff plans with any pulse rate. However, TRAI has retained the existing cap of 25 tariff plans that can be offered including both post-paid and pre-paid.

As you may know, service providers levy hefty charges for calls and SMS made for premium services. The reason given for the high charges is that it includes the price for content. But the regulator has argued that participating in competition and voting hardly involves any content. As such, tariffs for such calls and SMS should not exceed four times of the applicable local call or SMS charges. This move does offer some relief to customers. On the other hand, the pricing power of telecom players would be affected to some extent.

In investing parlance, the ideal P/E ratio of a firm is nothing but the price divided by the earnings of the share. But mind you, the earnings are not any random earnings but what we call as the normalised earnings of the company. The business environment, you see, is quite volatile. Hence, it would be wrong to use any one's year's earnings for the calculation of the intrinsic value of the company. The earnings are thus normalised over a period of 5-7 years. This takes into account the fluctuations in the business environment. It also presents a true picture of the earnings power of the firm. If we were to use this same principle to evaluate index heavyweight Reliance Industries' recent financial performance, the company's results may look a lot worse than what has been reported. Apparently, the company's huge cash hoard has come to its rescue as nearly half of its Profit before Tax during 4QFY12 has come from other income. In other words, the company has made as much money from surplus cash as it has from its core businesses. Its real earnings are really gasping for breath we believe.

The few banks that have posted their full year results so far did not offer any surprises. Besides the slowdown in loan growth, there was just the anxiety about restructured assets. However, so far at least there has not been any case of unusual spurt in NPAs. But trust our central bank to smell the rat before anyone else does. The Reserve Bank of India (RBI) has been worried with the spurt in lending against gold. NBFCs in particular have been very aggressive in this asset class, with gold prices becoming increasingly speculative in nature. In fact not just NBFC but also banks were offering much higher loans against the same amount of gold. This is thanks to the rise in prices of the yellow metal over the past year.

The RBI is in no mood to allow borrowers to speculate on the basis of rise in value of collateral. The rise in loan to value ratio of gold loans was mooted precisely to curb this. The subprime housing bubble of 2008 came handy to remind the central bank of the downsides of excessive leverage. We do not think the RBI has offered any hints of correction in gold prices with the precautionary mandate. That gold continues to remain a safe haven asset class is uncontested. However, overleveraging and speculative trends can be very painful for an economy in the long run. All credit to the RBI to nip the problem at its bud!

It's been almost five years since the global financial crisis and the outlook for the global economy is not something to cheer about. The developed world is still struggling to shake off the crippling effects of recession. Massive debt, high unemployment and tepid growth are taking a toll on these countries. While most of these nations have chosen to throw money at their problems, the same have hardly yielded the desired results. So what is it that will cure the ills of these economies Chinese premier Wen Jiabao opines that technical innovation and investment in the real economy will be the key to sustaining any recovery. He does have a point. For instance, one of the reasons why the US had become a force to reckon with in the past was precisely because of innovation. Thus, governments of both the US and Europe will have to come out with more meaningful long term solutions to kick start growth of their economies. More of money printing is a very short term solution which will only compound problems in the future.

In the meanwhile, after opening the day in the positive zone, the Indian stock markets are now trading in the red. At the time of writing, BSE Sensex was down by 147 points (0.9%). Stocks in the realty and technology sectors are witnessing selling pressure. The other major Asian stock markets have closed the day in the red with Hong Kong and Singapore witnessing maximum losses. European markets too have opened the day on a negative note.

 Today's Investing mantra
"Although it's easy to forget sometimes, a share is not a lottery ticket... it's part-ownership of a business." - Peter Lynch

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3 Responses to "What to do when your favourite stock crashes?"

Balbir Singh

Jul 18, 2012

Your views are excellent. However, in case the company is a reputed one then an option to average out the buy price can also be exercised.


Girish Sumaria

Apr 23, 2012

There should be nothing like favorite stock for a long term investor. This goes well for a trader who has more to benefit from daily price movements!
Every stock, whatever the fundamentals, can become over priced sometimes and that's the time you should control your LOVE for that stock....



Apr 23, 2012

i agree with your views

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