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When to walk out of your marriage with a stock?

Apr 8, 2015

In this issue:
» Does the Nifty reflect slow earnings growth?
» Should the US Fed raise rates?
» Why El-Erian is almost entirely in cash...
» ...and more!

00:00
When Warren Buffett revealed in 2011, that Berkshire Hathaway had purchased a stake in IBM, considerable eyebrows were raised. After all, the legendary investor had, in his earlier letters to shareholders, quite clearly stated his reasons for not touching tech stocks.

Buffett is, of course, allowed to change his views. Indeed, he didn't buy railroad companies for a long time either. But then went on to invest in Burlington Northern Santa Fe (BNSF) in 2009, and this has so far worked well for him.

What interested us though was the reason why he chose to invest in IBM. According to him he had been studying the company for some time but what tipped the scale was the roadmap that IBM had laid out in its annual report for the 5 year period ending in 2015. The clarity expressed there about where the company was headed and what it was planning to do convinced him. A bit of research on the position that IBM held within IT departments of various Berkshire group companies also helped. Indeed, as reported in an article on The Street, as of December 2014, Berkshire had a 7.8% ownership stake in IBM and the latter ranked fourth in his portfolio in terms of weightage.

IBM, since then has struggled as it has been battling various headwinds, which have impacted earnings quite a bit. As a result of which the article has questioned whether Buffett has made a mistake in purchasing the stock in the first place.

We have not analysed IBM's performance to form a view whether Buffett has made the right decision or not. What matters to us is the process. Obviously, Buffett invested in the stock from a longer time frame perspective and a couple of tough quarters in that sense do not matter as long as the long term business fundamentals remain intact. And therein lies the crux. However, if there are signals emerging that IBM is abandoning its roadmap and doing something that Buffett does not like, then it makes sense for him to consider exiting the stock.

We have also had examples of stocks that we had recommended to our subscribers wherein the business models and the strategy laid out by the company management were very sound at the time. However, somewhere along the line, these very companies lost focus and made decisions that had no relevance to the core operations. And hence staying invested in these businesses made no sense.

Indeed, a couple of tough quarters should not bother investors too much. As long as the business model remains robust and the company management is strong, such companies will tide over the storm. But if the decline in performance highlights a bigger problem at hand or if the management makes decisions that render the reasons for buying the stock invalid, then investors should certainly consider exiting the same.

Will you exit a stock based on poor performance in a couple of quarters? Let us know your comments or share your views in the Equitymaster Club.

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02:28
  Chart of the day
One of the key reasons for the volatility amongst the broader markets in recent times has been the earnings growth not keeping up with expectations. With P/E valuations hovering around the frothy zone, the hopes have been high for an upsurge in profits ever since the new government has come into power. However, it turns out that the financial performance in the recent times has been quite dull. Today's chart of the day gives an indication of the combined financial performance over the past four quarters of the companies that are part of the Nifty index. As you can see, post June 2014, the slowdown has been very evident amongst India's largest businesses.

Nifty: Is the slow earnings growth priced in?

As per the Economic Times, the dull period is likely to continue for the quarter ended March 2015 given that there are no strong indications of a pickup in demand; and that things are likely to only pick up in the second half of the current fiscal year.

Having said that, what is likely to provide a strong fillip to the earnings growth is the overall pickup in capex cycle. Not to mention the declining interest rates as well. A combined impact of these aspects is likely to aid in the overall expansion in margins which have otherwise been at their lowest in nearly a decade. So has been the case with the asset turnover, while not at its worst levels over the past fifteen years, was at the lowest levels in recent years in FY14; an indicator of there being good scope of improvement in utilisation levels going ahead.

Nevertheless, with large amounts of earnings growth downgrading having been done in recent times, it would be interesting to see how the market will react to this earning season considering that this development is pretty much known to all; but seems that it is yet to reflect in the sentiments as gauged by the valuations.

03:38
When it comes to the US markets, the biggest question occupying the minds of investors is whether the Fed is going to raise interest rates or not. Goldman Sachs is of the view that the Fed should hold off on raising rates. This is because inflation won't reach the central bank's target in the next three years.

Will the US Fed pay heed? Nobody really knows. So far, according to us, what comes across is that the US Fed is quite clueless. Near zero interest rate policies and the massive stimulus measures have so far only inflated asset prices. And has hardly contributed to meaningful growth in the economy. Whatever recovery is visible then appears fragile. And if the Fed raises rates, this could send the economy deeper into a recession. If this happens, the central bank will again resort to loose policies. And so the vicious circle will continue.

04:11
Former CEO and co-Chief Investment Officer of PIMCO, Mohamed El-Erian was in the news recently on comments of him being almost entirely in cash. And what's his rationale behind the same? Well... it's pretty simple - everything is pretty much elevated.

Commenting on the Fed's stance on keeping interest rates low, Mr. Erian is of the view that the central bank may be doing so because it may feel obliged to do so. As such, prices are being artificially lifted with the ZIRP in place. What this would essentially do is make people 'feel' wealthy and in the process, they would start to consume more. And this would make companies invest more. However, given that there is a major gap between asset prices and fundamentals, he is simply staying away.

Mr. Erian also pointed out that the present times remind him of 2007-08 when investors were trying to time the market. With wild intra-day swings in US stocks, it seems that investors are simply betting on the Fed's low interest rate regime to be around for a while considering that the job situation is not going as desired.

With US stocks trading at their most expensive levels in nearly a century, we only endorse Mr. Erian's view considering that the risk reward ratio is seemingly skewed in favor of the former.

04:45
The Indian markets continued their upswing as the day progressed. At the time of writing, the BSE-Sensex was trading higher by about 200 points (0.7%). Barring banking stocks, gains were seen across the board led by stocks from the realty and information technology spaces.

04:56
 Today's investing mantra
"The stock market is a no-called-strike game. You don't have to swing at everything--you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!'" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Radhika Pandit.

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Equitymaster requests your view! Post a comment on "When to walk out of your marriage with a stock?". Click here!

3 Responses to "When to walk out of your marriage with a stock?"

Kay ess

Apr 18, 2015

Irrespective of how much you have loved a stock,whether for it's growth potential,right market price or past performance,business model or even management,One thing you cannot afford is NOT TO DEFINE A DOWNSIDE RISK or STOP LOSS,which will be diffferent for different type oof market leaders,but for me ,it will be ,lets say about 20%.This has to be decided before the marriage,and when it plunges there,file for DIVORCE or declare TALAQ ....

Like (1)

sanjay Arora

Apr 8, 2015

I feghest potentialel one should exit when stock has its highest potential .

Like (1)

Ravi shah

Apr 8, 2015

Ms Radhika,For last one year i have been reading on your blog that crash is around the corner due to money printing but what we are getting is higher high levels in stocks as well as nifty rates.I think you are as cluless as FED.I m always scared in the back of mind that if market crashes then one can buy at attractive value but even after so much research your prediction cant come true then why wast our time?

Like (1)
  
Equitymaster requests your view! Post a comment on "When to walk out of your marriage with a stock?". Click here!
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