Time to Turn Contrarian and Exit Railway Stocks?

I think it was the maverick Jim Cramer who once remarked that there's always a bull market somewhere.

Well, if you look at the broader Indian indices, I don't think you can say they're in a bull market.

The Sensex has returned a little under 5% over the last one year, not a bull market by any stretch of imagination.

However, what about returns like 203%, 202%, 74%, and even 43% over the last one year?

Can you call this a bull market? Yes, think so.

These are the returns earned by Titagarh Wagons, RVNL, IRCON, and RITES respectively in the last one year. And if their magnitude is anything to go by, there is definitely a bull market underway here.

These four stocks have one more thing in common besides their impressive returns. Their fortunes are tied to the fortune of the railways sector in India.

If the railway industry in India grows at a fast pace, these stocks would be some of the biggest beneficiaries. No wonder, they also go by the name of railway stocks. In fact, even we have a stock quote page dedicated to railway stocks.

Anyways, this piece is not about whether you should buy railway stocks, especially after their crazy run-up in the last one year or so.

This piece is about the right exit strategy for them. Does it make sense to book profits or is there still a lot of steam left in these fast-chugging stocks?

The conventional wisdom about exit strategies is pretty straight-forward. It says that you should sell a stock if it meets one of the following three conditions.

• Your original thesis has changed.
• You realise you made a mistake.
• You've found a better opportunity.

No doubt, these are solid grounds for selling a stock. However, the problem lies in their execution.

How do you know whether your original thesis on a stock has changed? Perhaps, the change is only temporary in nature and the stock gets back on track in a few months.

Also, how do you know whether you made a mistake in analysing a stock? In fact, there could be a lot of confusion around what even qualifies as a mistake in the first place.

Lastly, the point about selling your stock if there is a better opportunity elsewhere is also sound in theory. But when it comes to practice, there are complexities galore.

How does one know for sure whether the other stock is a better opportunity or not? Do you judge it based on the business quality or the underlying valuations? Also, should the other stock be twice as better as the one you are considering selling or only marginally better?

I hope you are getting a fair idea on why selling is such a difficult thing to do. And this applies to not only the railway stocks under discussion but overall, as well.

You will find hundreds of pieces on the internet about how and when to sell your stocks. Still, it is their practical utility that leaves a lot to be desired.

Thus, if literature around selling is of little use, how about learning the art of selling from the personal experience of stock market gurus out there?

And when it comes to gurus, who better than Warren Buffett.

Can we look at Warren Buffett's selling history in order to understand his thought process around it? Does the Oracle of Omaha have an exit strategy that he has deployed repeatedly in the past?

I'm sure some of you are wondering that Warren Buffett is the wrong person to learn the art of selling from. After all, one of his favourite words are that his holding period is forever.

Put differently, once he buys something, he likes to hold it forever. So, what can a person who doesn't like selling, teach us about how and when to exit a stock?

Well, there's a difference between 'Buy & Hold' and 'Buy & Forget'. And Warren Buffett is certainly not the 'Buy & Forget' kind of investor.

His holding period may be forever, but he is known to sell a lot of stocks where he felt that their fundamentals had changed for the worse and they no longer deserved to be held forever.

Consider for e.g. Tesco, one of his most high profile investments. Warren Buffett first bought shares in this British supermarket giant back in 2006. However, he started selling the stock in 2013 and was out completely by 2014.

So, is there any lesson that we can learn from Buffett's holding of Tesco for around 7 years and then exiting completely within a span of one year?

Well, as per Buffett's own admission, he made a 'big mistake' in selling his Tesco shares as the supermarket's problems kept on escalating.

According to him, a more attentive investor would have sold Tesco much earlier and would have perhaps prevented the huge US$ 444 m in losses that he incurred in the stock.

The lesson here is that even a brilliant investor like Warren Buffett does not have a well-defined selling strategy and has committed errors like Tesco.

And if you thought Tesco was an exception, here's another one of his fiascos - Dexter Shoes.

Buffett bought Dexter Shoes back in 1993. And to make matters worse, he paid the US$ 433 m by way of acquisition cost in the form of Berkshire Hathaway stock. Instead of paying cash, he paid by way of Berkshire Hathaway shares worth US$ 433 m.

Around 8 years later, the Oracle of Omaha was left licking his wounds as the competitive advantage that he thought Dexter had, vanished. The company had to end shoe production in United States and another overseas location and what was left was merged into another Berkshire unit.

The loss to Buffett was not US$ 433 m that he paid to acquire Dexter. It was US$ 3.5 bn because the Berkshire shares that were worth US$ 433 m in 1993 were worth US$ 3.5 bn in 2001. As per Buffett's own admission, Dexter was the worst deal he had made back then.

I started this piece trying to get some insight into selling. I was looking for a good exit strategy so that I can help investors in stocks like Titagarh Wagons, RVNL, and IRCON, put together a sound exit plan.

But I have drawn a blank to be honest. The first strategy we discussed was good on paper but raised huge question marks in theory.

Then we tried to follow Warren Buffett and realised how even he lacked a coherent exit plan. In fact, we were surprised to know that he had made blunders you expect from a novice investor, not someone of the caliber of Buffett.

We are back to square one. We are yet to find a proper solution to the burning question that's on the mind of railway stock investors.

So when exactly should we sell our stocks?

I think we made a mistake while trying to look for a sound exit or selling strategy. We perhaps tried to look for complex solutions.

We thought that as there are so many factors involved, a selling strategy would be a multiple step process encompassing quite a few data points.

However, what we didn't consider was that in a field like investing, it's usually the simple thumb rules and back of the envelope calculations that prove to be more effective than complex solutions.

Yes, you read that right. Instead of looking for a complex selling strategy, how about we select an extremely simple one?

And there's one that I'm particularly fond of. The strategy is not only simple but has known to work across most stocks.

Once you buy a stock, you sell it after a 50-100% returns or a holding period of two years, whichever is earlier.

You see, for the first few years of my career, I was more about making big money from stocks. I was always on the lookout for the next multibagger. However, I did not have the success I expected.

Either I was wrong in estimating the strength of the company's competitive advantage or its management or both.

And on the rare occasions I got these elements right, I recommended the stocks at expensive valuations.

Consequently, big multibagger stocks were always elusive. I don't remember I ever succeeded in recommending a big, fat multibagger to my subscribers.

It was a little later that I realised that investing is not just about finding the next big, multibagger. As a matter of fact, you're likely to achieve more success in going after the more 'certain' money than the 'big' money.

Let me repeat that. If you have not had success making 'big' money from a handful of stocks, you can try betting on the 'more certain' money.

You see, most stocks are cheap at one price and expensive at another. Therefore, all you have to do is buy these stocks when they are available for cheap and sell them when they turn expensive. It's similar to buying a stock that you think is worth Rs 100 per share at Rs 60 or lower.

When viewed this way, selling becomes quite simple. You buy something at Rs 60 or lower and then sell it when it reaches Rs 100 or slightly higher.

As a matter of fact, this is exactly what I do in my recommendation services like Microcap Millionaires and Exponential Profits.

I recommend stocks trading at a good discount to their book value or are available at a PE multiple of 10-12x. I then recommend a SELL after they have gone up 50-100% from their recommended prices.

The close to 80% success rate I've achieved in doing this is proof that this approach does work over the long term.

As I said earlier, my goal is not to make 'big' money. It's not to recommend multibaggers. Instead, it's to try and guide my subscribers to make the more 'certain' money which they have made in 80% of the recommendation I've closed over the past few years.

So, to comeback to the original question of whether you should sell your railway stocks, evaluating the decision from the point of view of making 'more certain' money may help.

Are these stocks still trading at a PE multiple of 10-12x or are available below their book values? If the answer is 'yes' then perhaps one can consider investing in them even at current levels.

But if one has already made 50-100% returns in them or even higher, then a partial if not a full exit can certainly be considered.

My goal is not to earn multibagger returns from these stocks. For that, you need to assess the competitive advantages of these stocks in detail, take a call on the quality of the management, and estimate their earnings few years down the line.

I personally find this method to be complex and therefore, I'm happy with the 50-100% returns over 1-2 years. I'd rather earn a series of 50% returns across 4-5 different stocks than stay invested in a single stock in the hope that it turns into a 10-bagger.

I'm not saying that my approach is the right approach. All I am saying is that it's the one I'm more comfortable with. Likewise, you should also choose the one that suits your temperament better.

Happy investing.

Warm regards,


Rahul Shah
Editor and Research Analyst, Profit Hunter