Find a few great companies and then do less

Summary: Market volatility tests investors, but the current falling prices are driven by sentiment. If fear drives the decline in prices, then you shouldn’t fall in with the prevailing panic. Instead, stay invested in great companies to truly create wealth.

Last week continued with the trend of volatility that has prevailed across this month. Global uncertainty, coupled with fresh worries around tariffs and trade restrictions, led markets to lose ground, especially in the small- and midcap segments. As is natural and understandable, the price swings have rattled many investors. This volatility has been largely due to the broader market decline or weak Q3 numbers. However, fundamentals for our recommendations remain rock-solid. Let’s illustrate by highlighting a few trends.

First of all, what exactly happened?

Global uncertainty and fears of higher trade barriers have shadowed Indian stock markets since the beginning of this year. The BSE Sensex and Nifty 50 are down 3.34 per cent and 6.96 per cent, respectively, since 1st January this year. The decline in the NSE Mid and NSE Small cap indices was sharper, down by 5.37 per cent and 7.93 per cent, respectively. Our own recommendations have fallen, too, neither more nor less.

A fall in price, by itself, is not a reason to panic. It is also not a reason to do nothing. The right response is to check whether anything meaningful has changed in the company’s earnings power and business economics. That is what matters. If the fundamentals are intact and only the price has declined, the best course of action is often to stay disciplined. And if the fundamentals have changed, you have a genuine problem on your hands.

While concerns about falling stock prices are valid, we should not panic. Holding on to your investments through tough times is what investing really is. We easily hold on to our stocks and even cheer as the portfolio value goes up, but when the reverse happens, and the portfolio value declines, that is a time to step back, and more importantly, not log in and check portfolio values on a day when the market closes in the red.

This behaviour does not mean we ignore real-world realities. The truth is, with all the uncertainty around, the fears are real. But acting on fear before it turns into facts can cost you dearly. In markets, the anticipation of a problem often hurts more than the problem itself. Even when fears materialise, the best course of action is often not to panic and sell, but to maintain long-term discipline, as seen in the real-life example below.

When the COVID-19 pandemic came in 2020, the BSE500 Index fell 37 per cent. And Value Research Stock Advisor recommendations at that time faced a similar decline. However, one of our recommendations was asymmetrically hit by the pan-India lockdown.

We didn't issue a Sell call during the ensuing shutdown, even as the company bled and burnt cash and reserves. We understood that when things get back to normal, as they usually do, this business would recover in grand fashion.

Five years since COVID came and went, Value Research Stock Advisor recommendations have outperformed the BSE500 index handily. This includes the current market sell-off.

In essence, a portfolio of conservatively managed stocks, of high-quality businesses, reliable managements and low debt, beats the broad market that includes many shooting stars, undiscovered gems and hidden wonders. This is the beauty and reality of value investing.

And what happened to the completely downtrodden stock we just mentioned? The one completely shattered by the lockdown. While its Q3 numbers are shaky, if you had held on through the COVID-19 pandemic, you would have outpaced the Nifty 500 by a significant margin.

Despite the recent issues that have hit this particular recommendation, we’ve held on. That is the difficult part of investing. Holding on. And this case highlights that when people are fearful, usually the panic supersedes the logic surrounding its fundamentals.

Compare that with the uncertainty today, which has yet to directly affect the operations of several companies, whose stock prices are down 15-20, even 30 per cent, and you will understand why we insist on business fundamentals rather than the stock price. If the fundamentals continue to hold, if business economics are not changed, and if management continues to execute, earnings will come back, and with it the stock returns.

So the next time you see a stock you hold lose its value, the first thing you should do is check whether there has been any change in the fundamentals, in the company's earnings power. Look for three things:

1. Has long-term earnings power weakened in a lasting way? 
2. Has balance sheet risk risen meaningfully? 
3. Has management credibility weakened through actions or disclosure? 

If the answer to any of these is yes, you have work to do. If the answer is no, and only the stock price has fallen, you should not worry excessively. Remember, in the short term, it is very difficult for any company to consistently keep up with market returns. Only the long term will determine a stock's performance. That is what ultimately matters.

We’re reminded of the great Charlie Munger’s saying: “Investing is where you find a few great companies and then sit on your ass.”

And that’s what most investors struggle with – the sitting part. You need to be patient to benefit from a great business. 

Luckily, Value Research Stock Advisor helps you stay anchored through times like these. If you invest in our recommendations, you’ll never have to worry about monitoring them. We offer buy, sell, and hold calls to help you make the best investment decisions under pressure. For instance, if we had issued a sell call in the case of our mystery stock, people would have left a lot of money on the table.

Lastly, our weekly Subscriber’s Update gives you a complete overview of the performance of our recommendations. After all, our goal is to be in constant touch with the customers of Value Research Stock Advisor. You’ll feel encouraged to continue holding onto great businesses with our analysts offering constant, clear-eyed guidance.

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Also read: The importance of value investing