No One Ever Went Broke Taking a Profit... Really?

Aug 16, 2016

In this issue:
» Infosys' Contract Loss Highlights Risks for Indian IT
» Retail Investors Lapping Up IPOs
» ...and more!
Rohan Pinto, Research analyst

In 2013, I had just graduated with a masters in finance with an offer in hand to join a company from campus placement (and with an education loan to boot). With a passion and inquisitiveness to invest, I started my investing journey and hoped to make decent returns. I stumbled across a stock after some detailed analysis. I thought the company could give me at least a 15% compounded return on my investment. Meanwhile, I continued to pay a ridiculous 12% interest rate on my education loan.

Where did I invest?

A housing finance company trading at significant discount to its book value. I figured the company was trading at cheap valuations and would provide reasonable returns in future. The housing finance segment was a stable loan portfolio where default rates were low and there was huge demand for small ticket housing loans. This company ran a puny loan book compared to other housing finance companies' loan books.

With a bit of timing luck, the stock ran up in short time. Throughout the next year, a series of fortunate events took place. First, markets that were despondent in August 2013 suddenly turned euphoric in 2014. This was based on the prospect of then prime ministerial candidate Narenda Modi winning the election and ushering in happy days across India.

My housing finance company reported decent numbers. And some institutions were quick to recognise the company's potential and invested a sizable chunk in the company. In short, the stock got re-rated. I was up 100% within a year. I was elated, and my mind raced with thoughts.

Sell the stock! Pocket your returns! Pay off the loan!

The fundamentals of the company had gotten better with each quarter. I told myself the stock would correct soon and I could buy it again at lower levels. I sold my investment and thought no one went broke taking a profit. With the proceeds, I paid off my loan a couple of years early.

Cut to the 2016. The stock is up more than twelve times my 2013 purchase price. I learned a very old lesson. Phil Fisher sums this up the best...

  • One of my early clients made a remark that, while it is factually correct, is completely unrealistic when he said, "Nobody ever went broke taking a profit...

    Some years ago I was the adviser to a profit-sharing trust for a large commodities dealer. I bought for them - I think the stock has been split 15 times since then - a block of Texas Instruments at $14 a share. When the stock got up to $28, the pressure got so strong ('Well, why don't we sell half of it, so as to get our bait back?') I had all I could do to hold them until it got to $35. Then the same argument: 'Phil, sell some of it; we can buy it back when it gets down again.'

    That is a totally ridiculous argument. Either this is a better investment than another one or a worse one. Getting your bait back is just a question of psychological comfort. It doesn't have anything to do with whether it is the right move or not.

    But, at any rate, we did that. The stock subsequently went above $250 within two or three years. Then it had a wide open break and fell to the mid-50s. But it didn't go down to $35.

These errors in judgement do not show up in my investment returns data. They are an opportunity lost. No one knows about them except me (well, until now...). I paid a big price for my short-term thinking.

Similar to this, is selling part of your stock to recover your cost price fallacy. It is the same story: Sell out early and miss the magic of compounding.

While I was theoretically right to assume there'd be a correction in the stock, unfortunately for me, the stock never dropped below my sell price and I never bought back in.

  • In theory, there is no difference between theory and practice. In practice there is. - Yogi Berra.

I now know one way to fight the urge to sell prematurely is with longer investment horizons. If you have bought a fundamentally sound stock at a reasonable valuation, you are more likely to be rewarded in the long run. The key is to remain patient.

It is always prudent to have an investment horizon of at least 3-5 years. Give yourself a chance for compounding to work for you.

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Yesterday, was not a happy Independence day for Infosys. India's second largest software firm lost a major contract. Royal Bank of Scotland which had awarded a 5-year Euro 300 m contract to Infosys and IBM, has now cancelled the deal. Infosys was to be the major partner in the contract and the cancelation will impact about 3,000 employees.

This is the new reality for Indian IT firms. The financial industry is the biggest market for India's IT sector. The western world struggling with negligible growth and low/negative interest rates. The financial industry is cutting costs wherever it can. This has led to major cut backs in discretionary spending, including spending on software.

While Infosys is strong enough to weather the impact of this blow, the same can't be said for all Indian IT firms. Investors will have to be very careful and selective in picking stocks in this space. They will need to factor in risks of contract losses, into the valuations they are willing to pay for these stocks.

04.00 Chart of the Day

When speaking of risks in the stock market, a discussion on IPOs can never be far way. Sadly, retail investors don't seem to care. IPOs attract retail investors in droves during bull markets. The lure of quick profits is just too much to resist. Today's chart clearly highlights this trend.

Huge Retail Participation in IPOs

Usually, the retail investor quota in any IPO does not get fully subscribed on day one. However, times have changed. A shortened listing time, an easy online ASBA application process, and early success with a few IPOs, have paved the way for greed to take over the minds of a large number of retail investors.

This is a cause for concern. We believe the lure of listing gains can lead investors astray. Paying insane valuations for a company with an uncertain future during its IPO can lead to a huge loss. History is proof of that.


By the way, my colleague Vivek Kaul, has brilliantly explained what you probably did not hear about GST from the mainstream media. Over 15,000 people have downloaded Vivek's free report on the GST! I strongly recommend that you download 'GST & You: What the Media DID NOT TELL YOU About the GST' right away!


After opening the day flat, the Indian stock markets fell below the dotted line. At the time of writing the BSE-Sensex was trading lower by about 150 points (down 0.5%), while the NSE Nifty was trading lower by 52 points (down 0.6%). Sectoral indices were trading mixed with IT and Auto stocks bearing the brunt of the selling pressure.

04.55 Today's Investing Mantra

"I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rohan Pinto (Research Analyst).

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