Under performing stocks: What should you do with them?

Markets are at all-time highs, yet large number of investors are dismayed by the under performance of their portfolios. Yogesh Supekar and Tanay Loya delve into the reasons for the under performance of individual portfolios and suggest some remedial measures.



Millions of individual investors in India are faced with a unique situation in CY18 so far, where the broader markets are under performing the key benchmark indices by a huge margin. The irony of the situation is that most of the investors find themselves invested in the broader markets, i.e mid-caps and small-caps, rather than the large-caps. The current under performance of the mid-caps and small-caps have caught majority of the investors on the wrong foot. The underperformance is anything but startling for retail investors. Says Sandeep Kulkarni, who has been investing in equities since last 5 years, "I could not believe my eyes when I read a financial daily which says that Nifty and Sensex are at their respective all-time highs and that Sensex is up by more than 6 per cent on a YTD basis. My portfolio is down by more than 30 per cent on a YTD basis. Now, I do not know whether I should average the cost price of my current holdings or I should add fresh shares in my portfolio. Most importantly, I am confused about what I should do with my under performing stocks?"

 

Why do investors have a mid-cap bias? 

In the investing world, it is observed that majority of investors chase returns. It is common to witness frenzied buying in the asset class that has outperformed recently. Similarly, it is common to witness preference for investing in those stocks that have shown relative outperformance lately. Mid-caps and small-caps hugely outperformed large-caps in the past 3 to 5 years and majority of the retail investors expected the outperformance to continue in the mid-cap and small-cap space. This expectation of outperformance in mid-caps and small-caps prompted a majority of the investors to skew their portfolios in favour of mid-caps and small-caps. 

Under performance in mid-caps and small-caps 

If we try to assess the damage done by the mid-caps in CY18 alone, one can imagine the drawdown in portfolio values of investors. If we consider the BSE 500 index, out of the 500 listed stocks, there are nearly 149 stocks that have generated negative returns in the range of 25 to 50 per cent. There are almost 16 stocks that have generated negative returns in excess of 50 per cent. (Refer to the list of stocks below). 



Almost 56 per cent of the Sensex-30 index stocks have generated negative returns, while 72 per cent of the Mid-cap index constituents have generated negative returns on a YTD basis. Similarly, 84 per cent of the small-cap index constituents generated negative returns on a YTD basis. There are almost 91 stocks within the small-cap index that are down by more than 50 per cent on a YTD basis.
 

For all the listed stocks on the bourses, we can see that June month saw the maximum number of stocks hitting their 52-week lows, while the January month saw maximum number of 52-week highs on a YTD basis . 

As on July 11, out of 5,484 stocks that are listed on the bourses and 2,644 companies that trade with some volumes on the bourses, almost 2,277 stocks underperformed Sensex on a YTD basis in CY18. Merely 365 stocks outperformed Sensex on a YTD basis in CY18 

Your stock isn’t performing, your investment theme isn’t working, or you have better opportunities right in front of you, all these three reasons are good enough for you to exit from an underperforming stock. 

Down markets offer buying opportunities, but lapping up shares just because their prices are beaten down is no different from selling them just because their prices went up

Getting Rid Of Loser In Portfolio 

Investors have a tendency to hold on to their stock ideas even if the stocks are under performing for several years together. This tendency of holding on to under performers for years together is seen to be one of the major reasons behind the poor portfolio performance. Says Rohit Bhandari , "I am holding on to several of my stocks that are under performing in the current market situation, as previously I have noticed that whenever I sold my losing positions, the same stocks started doing well after I sold them. Also, you never know when these losers will become winners. Hence I am holding onto my under performers and not getting rid of them". True, it is impossible to predict if losers can be winners and by when. One must understand that stock market investing game is all amount probabilities and not possibilities. 

The better way of managing an equity portfolio is to get rid of losers as early as possible and sit on them again when they turn winners. It makes no sense to sit on losers for long, as not only they eat up your time and capital, they also kill any possibility of investing in prospective winners. If your investments are not working for you after giving them a reasonable period of time to perform as per your expectations, chances are that they are not going to start performing all of a sudden just because you have bought it. The stock prices won't move to prove that you are right. 

While there is always a possibility of an under performing stock to start performing as per expectation, one is better off getting rid of losers and replacing them with more promising ones. Says Prashant Raskar, who is a small-time investor, "I now realise it would have been better if I had booked my losses in one of the PSU banks and moved on with my investments in any of the leading private banking stocks. I thought the prices will recover for the PSU bank I had invested in as they had fallen sharply, but to my dismay, the prices are dropping further. Moving on to more promising prospects surely is better for my portfolio- anytime". Normally, lot of investors think that they will be taking a huge risk if they book losses in under performing stocks. However, the reality is that the investors are taking a bigger portfolio risk by holding on to the under performers. The fear that the under performing stock

1.Original investment rationale does not hold
2. Corporate governance issue
3.Management outlook is extremely optimistic, but the reality is not matching in terms of performance
4. The fundamentals of the company have deteriorated
5. The sector is going through a turmoil, e.g., telecom and textiles
6. Exit from an under performing stock unless it qualifies as a fresh buy at the current levels. In other words, would you consider buying the same stocks afresh at the current price? If yes, then hold on to the stock; if no, then exit. will touch record highs after they book their losses keeps the investors away from booking losses in the under performers. 

Jayant Manglik
President, Religare Broking Ltd

The mid-cap and small-cap indices had outperformed the large-cap index by a considerable margin over the past 3-4 years, which had pushed the former's valuations to life-time highs and around 2x of their own peak valuations of 24-26x on several occasions in the past. The 18% and 28% correction witnessed in the Nifty Mid-cap and Small-cap indices, respectively, in 2018 must be looked at in the backdrop of their erstwhile rich valuations and also the SEBI's reallocation guidelines for mutual funds. 

Notably, while several quality companies are back in the valuation zones, wherein they can be once again considered from a medium-term investment horizon, to assume that the mid-cap and small-cap baskets have bottomed out would be a bit early. This is primarily because the rise in valuation in 2017 was witnessed without commensurate increase in earnings growth owing to the lingering impact of demonetisation and GST implementation, which still makes us stay cautious on these categories, despite the fact that these have corrected 20-30% from their peaks. 

We believe there will always be a few interesting companies in the mid-cap and small-cap categories that would tick all the right boxes. However, considering the challenges and uncertainties on the horizon in terms of higher raw material prices, a rising interest rate scenario, the benefits of GST implementation yet to materialize in terms of market share shift from unorganized to organized and a heavy election calendar over the next 12 months, we would continue to remain highly selective in the mid-cap and small-cap space. In terms of sectors, our preference remains for sectors expected to continue to deliver strong growth, such as auto and auto ancillary, private banks, housing/ consumer finance companies, consumer staples/ durables, IT and building products (paints, ceramics/tiles, plywood).

VK Sharma
Head PCG and Capital Market Strategy
HDFC Securities 


"We would advise investors to remain in large-caps and invest only 10-15% in small-caps or mid-caps"

What is your view on mid-caps and small-caps at this point of time? 

The mid-cap and small-cap stocks can outperform the large caps for the simple reason that these have fallen more than warranted due to the following reasons. 

First, these stocks have been simultaneously flushed out by mutual funds and PMS alike.

Second, earlier when one fund used to sell, there was always a buying fund. But when everyone has pressed the sale button together, obviously the price has taken a beating. 

Third, new money is not chasing small-caps. However, we would advise investors to remain in the large-caps and invest only 10-15% of their money in small-caps or mid-caps. 

How should investors trade/invest in those stocks which have given phenomenal returns in the past few years but are drastically down on a YTD basis? 

Investors can apply these yardsticks for safety: 

1. Choose stocks where the fundamentals have not changed, but prices have halved. 

2. There is no question, whatsoever, on the management's integrity. 

3. Not a single share of the promoters has been pledged. 

4. If the promoters themselves are buying at beaten down prices, it adds credence. 

5. There is still good visibility of earnings. Lastly, there is enough liquidity in the stock. This is very much essential as most of the money has been lost by investors when they continue to be on lower circuits for days together.

Why are investors finding CY18 tough even though Sensex is up by almost 7 per cent on a YTD basis and is among the best performing global indices? 

The reasons have been spelt out already. In order to understand, the real reason, we first have to understand that the domestic institutions have been larger buyers than the FIIs. It is the domestic funds that call the shots. The recent changes in the guidelines for funds by the regulator have been behind the disparity. As per the new guidelines, only the top 100 stocks by market cap are defined as large-caps. 

In other words, it is not the absolute market cap of a company that defines its category, but its relative size. So there can only be 100 stocks as large-caps, even if the markets multiply ten times from here. The stocks from 101 to 150 are mid-caps. Rest are all small-caps. 

So there are two markets out there, the large-cap and the rest. The fund money is going into large-caps. So, unless the MFs come out with special MF schemes for the small-caps, these are likely to be in exile 

Is it correct to say that mid-caps and smallcaps outperform large-caps in long term? If yes, by how much? 

No, it's not true. In selective periods of risk-on, the mid-caps and the small-caps do appreciably better. But, over a longer period of time, these stocks do not compensate for the risks taken. From April 2005 to January 29, 2018, the day of the all-time high, the Sensex has appreciated 460%, the Mid-cap index has risen 486% and the BSE Small-cap index by only 414%. 

Which sectors in your view will be impacted the most due to the ongoing trade war? 

Trade wars will take their first toll on international growth. So, everything will be impacted. However, we believe commodities will be the most impacted, whereas financial services, insurance, MFs will be least impacted. India's outperformance will be enhanced more in such a scenario as we are a largely inward-looking economy, with exports accounting for just 14% of our GDP.

Sudip Bandyopadhyay
Chairman, Inditrade Group 


"Remain invested in good quality stocks to benefit from India's economic upsurge"

What is your advise to those investors who are holding the beaten down stocks in the portfolio? 

Unless the Investor has a long term-view and the stocks under reference are fundamentally worth holding, it will be advisable for the investor to exit his position by taking advantage of some short term rally in the market. This may give him opportunities to redeploy the proceeds in fundamentally sound large-cap and mid cap stocks available at attractive valuations post the recent market corrections. This reshuffling of portfolio will help him in optimizing the return when the tide turns. 

Will the second-half of CY18 be better than the first-half for the Indian equities? 

It is unlikely that the second-half of the current calendar year will be significantly different. While the global noise may come down, there are enough domestic triggers to keep the markets volatile. The forthcoming key state assembly and parliamentary elections will lead to volatility in administrative decisionmaking and uncertainties. Also, the increasing domestic inflation is likely to push up interest rates, thereby affecting the margins. Thus, though the corporate performance is improving and rural demand is picking up, significant upside in the market during the second half of the current calendar year may not be possible. 

What sort of returns can an investor expect over 3 to 5-year horizon from here on, if invested in equity diversified portfolio? 

While it may be difficult to predict the exact investment returns over the five years term on a diversified equity portfolio, it would be safe to predict a return in the range of at least 15-20% over this time period. However, the stock selection should be appropriate with significant bias towards large-cap and good mid-cap stocks.

High performance stocks in the recent past have underperformed in CY18 


We find that companies that had shown phenomenal performance in the past three years have shown negative returns on a YTD basis in CY18. We studied the performance of those stocks with market cap greater than Rs.1,000 crore and have generated abnormal returns in the past 3 years. Out of the 12 companies with market cap greater than Rs.1,000 crore and which have generated returns in excess of 100 per cent on an annualised basis, almost 10 companies have delivered negative returns on a YTD basis. Out of 75 companies which have generated annualised returns in the range of 50 to 100 per cent in the past three years, almost 62 companies have delivered negative returns on a YTD basis in CY18.

 

Foram Parekh
Fundamental Analyst, Indiabulls Ventures Ltd.

"The Mid-cap and Small-cap indices have corrected almost 50% from their peaks and are now trading at decent levels. As we are anticipating good Q1 earnings for IT, banks, FMCG, auto, auto ancillary, HFC and NBFC sectors, quality mid-caps and small-caps companies of these sectors will be a buying opportunity at the current levels. Many mid-cap and small-cap companies have reduced their debt, finished their expansion plans and will reap the benefits of their investments. Hence, it is an ideal time to invest in good quality mid-cap and small-cap stocks. It is advisable to not time the market, but spend more time in the market. 

As the mid-caps and small caps are all trading at very low valuations, the risk is low and the reward is exponential. For instance, good quality midcaps like DHFL and GNFC are trading in single digit valuations, when the entire index is trading at rich valuations. Also, companies like Parag Milk, West life Development have good product portfolios. Moreover, the products have good geographic presence and are expected to do well in tier-II and tier-III cities. All these make such stocks a good buy. 

Also, there are successful turnaround companies or the companies which are on the verge of a turnaround which can be accumulated in the correction of mid-cap and small-cap stocks. For example, GMR Infra is one among such turnaround companies. The company has created massive opportunity from the airport business which also contributes highest to the segmental revenue. Moreover, mid-cap and small-cap stocks like Jubilant Foodworks, Bata, etc continued to touch 52-week high on account of good financials. Hence, the companies with good corporate governance and good financials will always reward the shareholders in any market situation. Though the small-cap index is marginally overvalued than the mid-cap index, the steep correction in the mid-cap and small-cap is bottomed out and investors can look to enter at current levels."

What to do with under performing stocks? 

Having under performing stocks in one's portfolio is quite "irritating", but it may be "unavoidable" even for the best of investors. While it is common to have under performing stocks in the portfolio, the million-dollar question is: what to do with the under performing stocks in the portfolio? The trick for most of the investors is to not allow the under performing stocks to drain the portfolio returns as what ultimately matters is the overall portfolio performance and not how bad the under performing stocks are doing. If an investor allows under performing stocks to dominate the portfolio returns, it simply means there is something wrong in the way portfolio is being managed. Investors will see under performing stocks dominating their portfolio returns under following circumstances:- 

i) Risk profiling is not done by the investor and hence the portfolio is skewed toward highly volatile mid-caps and small-caps.
ii) Proper weightages are not assigned to stocks in the portfolio and, therefore, investors are often found overweight on under performing stocks.
iii) Basics of portfolio management is not adhered to and investors are stuck with concentrated portfolio of under performers, whereas diversified portfolio could be the need of the hour.
iv) Investors find it difficult to get rid of losers and are often sticky about their stock picks. Ideally, any investor should track the QoQ performance of the portfolio holdings and get rid of those stocks that are showing poor quarterly performance.
v) Investors at times adopt leverage buying strategy in poor quality stocks. A marginal drop in prices of such poor quality stocks impact the portfolio performance due to the portfolio being leveraged. 

A smart investor may avoid all the above mentioned errors, yet he may be still faced with a situation where the individual stocks are under performing the benchmark. Following steps are recommended for an investor who is stuck up with under performing stocks in the portfolio:- 

1.Study the core reason for the under performance
2.Check the market outlook going forward
3.Study the sectoral outlook of the under performing company
4.Re-evaluate the valuations
5.Check the management outlook on the growth prospects of the company
6.If the stock belongs to the commodity sector, check the commodity market outlook
7.Look out for and research on the next trigger in the stock.
8.Remain invested in the under performing stocks if your original investment rationale still holds good. Otherwise exit.

Mustafa Nadeem
CEO, Epic Research 

"There can be numerous ways. One must focus on cutting losses when we talk about trading perspective, while in terms of investing for the medium-term, we suggest adding out performers of the previous rally. Now to deal with under performing stocks requires tactical asset allocation"

Conclusion 

Investors who have followed the basic investing rules are seen doing well in the current market scenario. Those investors who have failed to adopt a portfolio approach are the ones who are suffering the most. To beat the markets, it is important that investors get their portfolio weightages right, along with right stock selection. The importance of rebalancing of portfolio is felt during times such as now when the broader markets are under performing. The down markets are excellent times to rebalance your portfolios, so one should focus on rebalancing your portfolio in times such as now. 

No matter how mysteriously difficult the process of getting rid of losers and including winners in the portfolio can be, investors will have to eventually learn the specifics of the process in order to beat the markets in the long term. 

It is very easy to get swayed by the market moods and be pessimist on the overall markets if your portfolio is not doing well. However, the moments of market stress is not the time to decide on abandoning the carefully-constructed equity portfolio. Investors should not give in to panic or greed — ever. Also, investors will gain if they avoid investing in scrips that have recently shown abnormal returns, as the high performance stocks of the past few years typically become low-performing stocks of the next few years. In spite of the visible headwinds in the form of rising interest rates in the US, trade war impact, weakening rupee and the rising crude oil prices, the earnings seasons is expected to bring some excitement in the markets. At this moment, given the increased perception of risk in the markets, investors should invest with utmost caution and follow the basic investing rules in order to prevent the under performing stocks from dominating their portfolio returns.