Over the last couple of weeks, there has been a lot of buzz with some of the stocks having fallen between a minimum of 15% – 20% to as high as 50% – 90% from their 52-week highs. This is usually followed by comments from the so-called pundits or experts that while the captioned stock has fallen by x%, it seems to be a good-bargain, or a value buy.
While the captioned stock could still be a good buy (after all, price is what you pay, value is what you get), however the mere fact that the stock’s price has fallen by some x% from its 52-Week high leads to one of the biggest fallacies in investing.
Humans don’t tend to evaluate things / stocks in absolute terms. They evaluate them relative to a comparison standard or a reference point. Here, 52-week high stock price, acts a reference point thereby leading to one of the most asinine investment follies.
When the stock price of Tata Motors fell by about 37% from January until June of this year (Jan 1, 2018 – INR 424.45; June 29, 2018: INR 269.30), one of the leading fund managers in his letters to shareholders referred to the fall as a “quotational loss and that the stock price offered an excellent buying opportunity due to a unilateral lowering of valuations”.
Quotational loss can be termed as a buying opportunity only when the franchise is excellent, with the underlying value remaining intact.
Obviously, reference point of January’s stock price was being envisioned. The other maxim which could have also been playing out in the mind then could have been of
mean reversion, i.e. asset price and return would eventually return to the long-run mean or average of the captioned stock.
The stock price fell by another 32% since June of this year (Nov 1, 2018: INR 180.90). Total shareholder value erosion since the start of this year was 57%, company now being nicknamed as “Ghata Motors” by harried investors.
Had the evaluation of the company been done on an Absolute Basis*, chances of loss of such a gargantuan nature could have been avoided – so much for having 52-Week High as a Reference point.
P.S.: To evaluate a stock on an Absolute Basis* or in an objective way, some of the following questions is required to be answered?
- Has the company been generating cash flows? Historically and recently?
- How has the company’s debt levels been? Increased / Decreased / Remained Stable – Why?
- What is the Return on Capital employed by the business? Historically and recently?
- How are you sure that the favourable trends will continue, if at all?
While answers to some of the above questions have been featured in my previous blog Being profitable is hardly the evidence of a good business even the recent Q2 results of the company have been extremely dismal. The company incurred loss of INR 10.48 Bln and Free cash flow for the quarter stood at a negative INR 43.57 Bln.
Disclaimer: Please note that these are my personal views. While, I am a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014, all investors are advised to conduct their own independent research into individual stocks or industries before making any decision. In addition, investors are advised that past stock performance is not indicative of future price action.