How to handle a big fall

If you own a good-quality stock, don't sell it just because it has fallen. On the contrary, think of accumulating it

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On May 17th, some of the stocks of the Anil Ambani group went up by some absurd amount. RCom was up over 40 per cent, Reliance Naval 25 per cent and so on. And why did this happen? News reports tell us that the reason was that Ericsson, a telecom-equipment supplier, had eased up on its move to get bankruptcy proceedings started against Reliance Communications. According to reports, Reliance Communications owes Rs100-odd crore to Ericsson, which it is unwilling or unable to pay.

To my mind, the stock market's reaction to this news sums up much that is wrong with equity investing in India. Look at what the actual event is. This group is universally known to be in deep financial straits. It's attempting to walk on thin air, carrying a crippling debt and supported by little more than a name. Since the split from the parent group, it has seen a steep downward spiral in almost every business it runs.

Any adjustment with Ericsson amounts to little more than rearranging the chairs on the deck of the Titanic. So who are these investors who think that RCom got 40 per cent more valuable in a few hours, merely because a formal declaration of bankruptcy has been postponed? Does the inherent value of a stock change that fast, and that too in response to a single event? The kind of punters who dominate the Indian equity markets certainly seem to think so.

However, I would not actually care - and no sensible investor should - if this bizarre behaviour was limited to such cases where there is some random positive news and a stock gets severely overvalued for a short period. Some people will make some money and some will lose some money, it's fine. There's a lot of randomness in the markets - there will always be. The problem with knee-jerk behaviour is more on the opposite side - investors running away from perfectly good stocks merely because the stock has fallen sharply. This is something that has been bothering us at Value Research as we look at many high-quality stocks closely for our new Stock Advisor service. When a quality stock falls, then the basic tenet of investing has to be that one should stay put and not sell out and run. In fact, the principles of value investing, or any type of fundamentally-driven investing, would say that this is the time to accumulate.

For a recent story, we selected a set of stocks that have earned investors huge returns over a long period, and then looked at their history. What we found is that in every case, there are times when there were huge drops in the stock price. Investors would have seen the value of their holding in the stock erode by big margins, of half or more. And yet, by concluding that it was time to move out of the stock, they have done even more damage to their own investments.

Of course, like all ideas in investing (and in fact, in any field of study), this idea should not be tried in reverse. Because many stocks that give great gains have big falls in their past, let's not conclude that all stocks that have big drops now will give us great gains in the future. Such simple heuristics do not work. The bottom line is always business and management quality.

The focus of our study is not that stocks that fall big eventually rise big, or even that stocks that have risen big have fallen big in the past. It's not about stock selection at all. Instead, like so many things in investing, it's about managing one's psychology. If you have chosen some stocks and you are confident, then do not let some hiccups bother you.

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