Winners Get Rid of Non-Performing Stocks

Nobody Loves a Loser, but only the wise have the guts to get rid of dud stocks. For others, a broken portfolio sounds better than a bruised ego

Published: Aug 23, 2010 06:57:44 AM IST
Updated: Aug 19, 2010 04:01:45 PM IST

For many, the current state of the market offers a sense of déjà vu that takes them back to the last quarter of calendar year 2007. The major indices regularly scaling new highs, the impressive breadth of gains across industries and the emergence of relatively unknown companies as the “superstars” is comforting terrain for those with a high level of expertise in pattern recognition. Corporate earnings are back on a firm footing though the benefits of a low base effect are now rapidly receding. What happened in between though has been profoundly sobering. First, a devastating market collapse triggered by “geeks bearing formulas that were sub-prime,” and then a malaise driven by heightened fears about Greeks — to say nothing about a host of others deep in hock. Despite the clamour among market mavens about the outlook being “long-term bullish” there is a palpable tension that is leading to schizophrenic behaviour. What lies at the root of this gnawing anxiety? The haunting memory of not heading for the exits in January 2008 is tormenting the minds of the best and the brightest.

The more an outcome appears to be the result of your own choice and the easier it is to imagine having done something different, the greater the pain caused by regret. So what happens to investors racked with regret? Most fail to panic; instead they simply freeze. Clinging on to losers in such circumstances might not equate with rational investing yet it prevents your ego getting bruised. You simply do not need to admit having made a mistake by postponing the sale and taking the loss! Even better, since you believe that tough times call for bold actions, why not “take some profits” and sell a winner. Such behaviour is the first step on the road to financially catastrophic investment results.

Counterfactual thinking transports you to a different world in which the outcomes are always knowable and the right thing to do is always obvious. Most money managers seem to have bragging rights about a multi-bagger they have bought during the last couple of months. Remember that they never talk about their mistakes. Avoid succumbing to the feeling of being the only one with investing regrets and being tempted into taking risks you normally would avoid. As an unknown smart aleck put it, “Nothing recedes like success.” Arrive at investment decisions not based on fear but on the conviction  inspired by sound business fundamentals and a time horizon measured in years, not months and quarters.

Central Bank of India (Rs. 175) offers a childishly simple but compelling investment hypothesis. Despite a troubled start to the decade, there are clear and visible signs that the business is on the mend. Non-performing assets are in control, profit margins are gradually improving and management is keen to re-build for the long haul by increasing provisioning coverage and coming to grips with operating expenses. Total assets for the year ending 31 March 2010 were Rs. 182,000 crore. Assuming 17 percent growth for the next couple of years, the bank will report a number in the proximity of Rs. 250,000 crore (total assets) for FY 2012. Considering that it is currently among the most highly leveraged banks in India, a rights issue of equity leading to 40 percent dilution is in the offing. Return on assets for FY 2010 came in at a moderate 78 basis points. Keeping in mind the gains likely to accrue from the current initiatives, one could be forgiven for looking forward to a ROA of 85 basis points! Put differently this works out to a book value of Rs. 170 and earnings per share of Rs. 38-39 in the next 18 months. Clearly, Central Bank is a sensible option for patient investors seeking to maximise the likelihood of preserving capital.

Stay calm, focus on the economic characteristics of the business that you own and how it is valued and do as little as possible to minimise regret. The existential philosopher Soren Kierkegaard summed it up nicely in saying, “Life can only be understood backwards; but it must be lived forward.”

Disclosure: This column is neither an offer to sell nor solicitation to buy any of the securities mentioned herein. The author, a partner at Fortuna Capital, frequently invests in the shares discussed by him.

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(This story appears in the 27 August, 2010 issue of Forbes India. To visit our Archives, click here.)

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