Warning! Do You Have These Stocks in Your Portfolio?

Editor's note: In times of extreme volatility in the market, you need to be extra cautious about the stocks that you are considering. In a recent editorial, Rahul Shah, Co-head of Research at Equitymaster, wrote about the kind of stocks you need to be cautious about in this market. Do you have such stocks in your portfolio? Read on...

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What do you think of this portfolio of 2 0 companies?

I have blurred the names of the companies to avoid any sort of biases.

None of these 20 companies have good fundamentals if you ask me.

They have each made losses in the last five years and either have a negative net worth or have debt on the balance sheet that is much higher than equity.

How do you think an equal weighted portfolio of these 20 companies would have performed in the stock market in 2024?

Guess the performance of these stocks as a portfolio in 2024.

Let me break the suspense. An equal weighted portfolio of these 20 stocks would have earned 40% returns in 2024.

Yes, that's true. A 20-stock portfolio of some of the worst companies fundamentally, would have done much better than the nearly 30% returns earned by the BSE Small cap index.

In other words, a portfolio of fundamentally bad companies would have outperformed the BSE Small Cap index by a significant margin in 2024.

Before we move further, let me reveal the names of these stocks to you. Here they are.

Yes, this is the portfolio that has given the BSE Small Cap index a convincing beating in 2024. There are some famous names here and some not so famous.

Now let us move a year back to 2023.

Again, we see a similar performance. A 20-stock portfolio of fundamentally bad companies had again outperformed the BSE Small cap index in 2023.

In fact, this time the performance is even better. A portfolio of fundamentally bad companies was up a whopping 75% as opposed to the 47% given by the BSE Small Cap index.

What exactly is happening here? Aren't we told to stay away from fundamentally bad stocks as these stocks are toxic and can harm our portfolio?

Shouldn't we only invest in fundamentally strong companies as these are the ones that outperform the benchmark index and lead to long term wealth creation?

Well, before we conclude that it is better to invest in a group of loss making and weak balance sheet companies compared to fundamentally strong ones, we will have to look at longer-term data.

We will have to look at a 10-year period at least to see whether a portfolio of toxic companies as I like to call them, does indeed outperform a portfolio of fundamentally strong companies or the benchmark index for that matter.

So, let's check out if this is really the case. Here's what I did.

I picked 20 toxic or fundamentally weak stocks at the start of the year and held them for one year. Then I picked 20 new stocks with the same characteristics and so on. I made an equal weighted portfolio of 20 stocks.

The stock qualified as a fundamentally weak stock if it had made back-to-back losses in the last 5 years, the more the merrier, and also had a negative debt to equity ratio or a debt-to-equity ratio of more than 1.

The stocks were also required to have a revenue of at least Rs 2 bn or Rs 200 crores for the latest year and an average daily liquidity of Rs 1 m or Rs 10 lakh.

We are now ready to sit back and watch the performance of this toxic or a portfolio of fundamentally weak stocks unfold.

Here's the year-by-year performance of this portfolio over the last 10 years i.e. between December 2014 and December 2024.

As we can see, although the portfolio companies has done very well in the years where the benchmark index (BSE Small Cap) has done well, it has done very poorly when the broader market has had a bad year.

The year 2018 and 2019 when the BSE Small Cap index had crashed, the portfolio of toxic stocks had crashed even more.

In these two years combined, it had lost almost 80% of its value.

So, in a bear market, investors really dumped these shares left, right, and centre and ran for the hills.

Hence, cumulatively, over a 10-year period, the toxic portfolio significantly underperformed the BSE Small cap index and gave a CAGR of just 10%.

In contrast, the BSE Small Cap index achieved a CAGR of 17%, turning every Rs 100 into Rs 500 as opposed to the toxic portfolio, which turned every Rs 100 into only Rs 270.

The verdict is quite clear. A portfolio of fundamentally bad companies or toxic stocks as I like to call them, can outperform in a bull market and perhaps even by a wide margin.

However, the wealth destruction in a bear market is so huge that it cancels all the good work done in a bull market and net-net, the portfolio ends up as a big underperformer. This is quite clear in our 10-year study.

Therefore, if you are keen to invest in a portfolio of fundamentally bad companies in the hope that you'll end up with market beating returns, do so at your own risk.

Of course, you could do well in a bull market and the outperformance could encourage you to put more money into this strategy. However, it could end up being a terrible mistake.

All the wealth that you had generated in a bull market could go up in smoke in a bear market and you may end up with a significantly below par performance.

By the way, take a look at this portfolio of 20 companies.

These are fundamentally some of the worst companies as they not only have a negative net worth, but they have also recorded losses in each of the last 5 years.

This portfolio is already down 20% in 2025 so far as compared to the 18% decline in the BSE Small Cap index. Hence, it is already performing worse than the benchmark index.

So, if you are expecting the markets to correct further and the small cap correction to get worse, you should stay away from fundamentally weak stocks.

You see, there is investment and then there is speculation. Investing in fundamentally weak companies or toxic stocks can't be called as investment to be honest.

At best, it's speculation and you should avoid speculation at all costs. You can do it with just 5% to 10% of your total corpus if you really want to, but never invest any serious money in it.

As we saw, the end result of speculation over the long term is either wealth destruction or very poor returns.

Therefore, while fundamentally poor companies can give you good returns for some time, the end result is almost always painful.

So, stay alert and stay away from toxic stocks.

Happy Investing.

Warm regards,


Rahul Shah
Editor and Research Analyst, Profit Hunter
Equitymaster Research Private Limited (formerly Equitymaster Agora Research Private Limited) (Research Analyst)