FC Mar'24 Newsletter - Don't catch a falling knife!

Cost averaging in an individual stock is not a prudent idea if done blindly, especially for small investors with limited resources. Investors need to aim to earn a return on their total investment. To maximize their return, they need to decide at the time of investing, which investment has the best return potential. If it is one of the stocks they are already holding, they should add to that holding. If it is some other investment option, they should invest in such a better option. Buying more of an underperforming stock if there are better options available would be a bad strategy. It might result in the dissipation of scarce resources (money), compounding of losses, and missing good opportunities.

Catching a falling knife

Not long ago, Future Retail Limited (FRL) was a famous company. The promoter of the company was considered a genius. He pioneered the organized retail business in India. Learning from global retail majors like Walmart (USA) and Asda (UK), he built a strong business in India. However, failure to manage growth and excessive debt created problems for FRL and several other group companies, eventually leading to insolvency. The problems for the group had started after the global financial crisis, but it survived for a few years through selling of assets and business restructuring. Covid-19 hit the company hard and it could never recover from that shock.

Post restructuring of the group in 2016, FRL hit a high of ~Rs634 in November 2017 and has been on a steady decline since then. At the time of Covid-19 breakout (February 2020) the stock of FRL was trading close to Rs350.

Tracking the stock movement from the high of 2017, we get this.

·???????? The Stock price fell 22% (635-493) in one year from November 2017 to November 2018.

·???????? If one got tempted to buy it in November 2018, it was down another 33% in the next year (November 2018-November 2019) from 493 to 330.

·???????? If one averaged it in 2019, it was down another 79% in the next year, from Rs 330 to Rs68.

·???????? In November 2020, if you thought that the stock is down 90 from its 2017 highs, and how much more it could fall, it was down another 29% in the next year to Rs48.

·???????? If one believed that it is now available at a dirt-cheap price and bought it, he would have lost 92% of his investment in the next year as the stock touched Rs4 on November 22.

·???????? If in November 2022, you thought there is not much to lose in this, the investments made in November 2022 are down by 50% as the current stock price is ~Rs2.

·???????? The investment made at this “lottery” price can still potentially lose 50% to 100%.

FRL is only one example. There are hundreds of stocks that were very popular at one point in time, fell 90-99.9% from their euphoric highs, and never recovered.

Therefore, before cost averaging, investors must understand that a stock down 90% from its high, is a stock that has fallen 25% from its immediate previous price eight consecutive times (100-75-56-42-32-24-18-13-10). If at any point of this journey, you thought that it has already fallen so much, how much more can fall – the answer is it can still fall another 90-100%.

Selling to buy lower

An investor needs to understand his/her limitations. Most investors do not possess the skills required to be a successful trader in the market. So, it is better to avoid trying these kinds of adventures. If you are comfortable with the fundamentals of the company, ignore day-to-day price movements and stay put. If you are not comfortable with the fundamentals of the company, ignore day to day price movements and exit at once.

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