Do not "HOLD TO ZERO"

“In fact, I predict one day Amazon will fail. Amazon will go bankrupt. If you look at large companies, their lifespans tend to be 30-plus years, not a hundred-plus years, ” said Jeff Bezos, Founder & CEO of Amazon. When the world's richest man says something, one better take note.

Quite a few studies have now penned down that average lifespan of S&P 500 companies is down to less than 20 years now as compared to 60 years back in 1950. 

• https://www.cnbc.com/2017/08/24/technology-killing-off-corporations-average-lifespan-of-company-under-20-years.html
• https://www.bbc.com/news/business-16611040 

While we are yet to get a study on survival rates of Indian businesses but only 13 companies are still a part of Nifty since inception in 1995. In a little over 20 years 75% companies are much less dominant today than what they were. The gems of yester years which have featured in the TOP 10 fastest wealth creators on many annual studies are now Zero or inching towards Zero - RCom, Jaypee, Unitech, Jindal Steel, PSU Banks, SAIL, Gujarat NRE Coke, HFCL, Aftek Infosys, Asian Electronics, Moser Baer & the list goes on. 

When life of businesses have been cut short, is it prudent to hold onto them for eternity ?
In our journey as an Investment Adviser, we have come across many clients who are clueless about their holdings. They have invested based on heresay, tips or advice which is not being followed up & sit on a pile of junk which makes no sense. So strong is the loss aversion that despite the string of poor business developments one has been lulled into inaction. Infact for many, buy & forget has become a style of investment. 

An investor is reckless if they don't look back & evaluate. To harbor the notion that if one holds long enough, something magical will happen is not sensible. At best, 1 out of 100 does recover but the portfolio has moved at a snail's pace probably under-performing even Nifty which has delivered 12% CAGR since inception. Thus I ended up coining this term for the devoted holders - 'HOLD TO ZERO'.  

It is exceedingly important to avoid this trap of blindly holding onto a stock as the age of a business surviving has reduced significantly. Only a handful shall remain as strong as today & maybe there peak performance on the market might happen much earlier. Even if they exist 20 years on, they might not deliver any returns. A classic example is Wipro which has practically not delivered any returns for the last 19 years infact on 16th Feb'2000 it traded at a price higher than it did on 16th Feb 2019. It must have been a 100 bagger from 1995 to 2000. The purchasing power of your investment in Wipro today is just 20% of what it was in 2000. 

 A story about Einstein is true for many investors in stocks too :-

Einstein was once traveling from Princeton on a train when the conductor came down the aisle, punching the tickets of every passenger. When he came to Einstein, Einstein reached in his vest pocket. He couldn’t find his ticket, so he reached in his trouser pockets. It wasn’t there, so he looked in his briefcase but couldn’t find it. Then he looked in the seat beside him. He still couldn’t find it.

The conductor said, ‘Dr. Einstein, I know who you are. We all know who you are. I’m sure you bought a ticket. Don’t worry about it.’

Einstein nodded appreciatively. The conductor continued down the aisle punching tickets. As he was ready to move to the next car, he turned around and saw the great physicist down on his hands and knees looking under his seat for his ticket.

The conductor rushed back and said, ‘Dr. Einstein, Dr. Einstein, don’t worry, I know who you are. No problem. You don’t need a ticket. I’m sure you bought one.’

Einstein looked at him and said, ‘Young man, I too, know who I am. What I don’t know is where I’m going.’

With many investors, the understanding of where they intend to reach with the investment made is missing. Unfortunately a lot of literature & some legendary investors emphasize on 'holding forever' or an even more vague description 'long term' which is blindly embraced by the naive investor. Even Warren Buffett has a 100% turnover. He blew out 30% of his portfolio selections within six months, and held about 20% of his picks for the longer run. His buy & sell decisions are not influenced by price only & are driven by business developments thus he is able to sit on his winners longer but that does not imply he does not sell.      

To sell right is just as important as buying right in most stocks. Ofcourse there are a few exceptions & one must have the ability to make that distinction. To categorize everything as a buy & hold is essentially Holding to Zero. 

Here are some FUNDAMENTAL factors that we ponder about. Most of them are a precursor to poor numbers :-

1. Change in the competitive landscape - Jio entering telecom
2. A large long gestation capex - Capex is important but in many industries like power, petchem, steel it takes forever for a plant to come on stream & the pressure on the balance sheet is tremendous. NMDC, JBF Industries are victims of this.
3. Working capital cycle - Elongation of the working capital cycle is serious cause for concern. This in due course will lead to rise in debt & business getting hampered.
4. Visibility of volume growth is missing - Coal India despite efforts is not able to increase its production meaningfully. 
5. A business pricing the current pricing environment into eternity - Maybe Chemical companies are being priced that China led supply disruption is permanent. Same is the case with graphite electrode manufacturers.
6. Governance issues coming out in the open - Dubious transfer of holding in a subsidiary to promoters as was the case with Meghmani or fraudulent lending/ manipulation by DHFL or Emami's acquisition of Keshking followed by an immediate writeoff.
7. A management under-performing - Often companies hit a hurdle, even if the industry does well or is poised to do well. Mirza International(Red Tape) has not been able to grow for the last 5 years & yet was commanding astronomical valuations.
8. Capital Allocation - Good businesses not being able to deploy cash productively is likely to result in mediocre returns. Buffett has discussed this in great detail & from MOIL to ITC we have plenty of companies not being able to do justice to the cash they are generating. 
9. Scarcity Premium - Plenty of businesses are held by a very close set of investors. Thus lack of liquidity results in lack of discovery. When there is a change in the former the correction can be quite steep.
10. Promoter is a seller - This can be a pretty grave problem as the supply can be never ending. PSU's are a good example. Pledging is another way of creating supply & so is dilution. Bandhan is a great franchise but a regulatory diktat to dilute the promoter holding means pricey acquisitions.   

Here are some BEHAVIORAL flaws that we have observed in many investors including ourselves :-

1. Anchoring to a price - At today's price if the stock is not offering a margin of safety then to harbor dreams for a higher price is irrational. At best one can choose to sell it in a staggered manner over a defined time frame. A systematic exit plan over a much smaller time frame.
2. Procrastination is a sin - Often one notices that investors look for a reason to delay the decision. Market today is a lot swifter, a stock could trade at a level for 6 months giving an impression of stability & within a matter of weeks(days for F&O stocks) the market could erode 50-60%. Thus often despite making the decision one gets lulled into inaction for one reason or the other.
3. False Hope - Be it loss aversion or endowment(love for what we own) but it gives rise to false hopes of an extraordinary change in the situation. Investors in Reliance Communication have been waiting for the big brother to invest. A PSU bank investor based on management commentary has been waiting for NPA's to end. This is a large market, it makes sense to move from uncertainty to certainty.
4. Unwilling to change - A change of mind is not a sin in the markets. If some assumptions do not hold good one should not get stuck. Even if one has committed publicly to the stock, it should not hold one back if there are changes.
5. Rationalizing being - Often we form an opinion first & then look for data to rationalize the same. We notice most investors have preset notions & look for data points to justify their belief. Look for data points that question one's thesis.

The market regularly presents opportunities, one must learn to wait & act. To be invested in anything & everything all the time is likely to deliver mediocre results.