There are three ways we can sell or scale out a position
Sell early or in other words sell into strength
Sell late or in other words sell into weakness
Sell at the absolute top
The first two options are known only in hindsight and the third option is a desire of many investors, but should never be the goal of a sensible investor. I know of no system where someone can sell at the top on a consistent basis (consistent being the key word)
All forms of investing and trading try to achieve an above average return on a consistent basis. So lets remove option c and focus on the other two options.
We have to pick our poison – Either sell early and leave some money on the table or sell late and see some of the paper gains evaporate. We use a mix of the two to minimize regret
For example, we sold some of Polycab, Apl apollo etc into strength in 2022 and 2023 and the balance was sold after we hit the peak and the stock started sliding. In these two cases, we sold some early based on position sizing and the rest once we hit the stoploss or due to some issue. In both cases, we achieved a decent return on the total position.
Both the stocks rose after we trimmed the positions in 2022/23 and polycab even doubled from our initial sale. For the portion we held on, we made a decent return but sold below the peak price
In effect, we had regrets after each transaction and that is the key point. No matter, what decision we make, we will have regrets. Sometimes the result of the action will be visible in months and sometimes after years (such as Balaji amines which went up 20X+ after we sold)
We are not trying to achieve perfection in any investment decision. We are trying to do a reasonable job and minimize (not eliminate regret).
This means that our transaction timing will be reasonable but never perfect, though we are making constant effort to improve the quality of these decisions
Disclaimer
This report is published by RC Capital Management – SEBI Registered Investment Advisor (INA000004088).
This report is for educational purposes only and should not be construed as an Investment Advice.
RC Capital Management may have recommended the above stocks to our clients in the past. However, this is not a recommendation to buy / hold / sell the stock at the time of publishing this report.
The securities quoted are for illustration purpose only and are not recommendatory
RC Capital Management does not hold any position in any of the companies mentioned in the report at the time of publishing the same. Its partners may hold a position in this company in their individual capacity at the time of publishing.
Neither RC Capital Management nor its partners have received any compensation from any company mentioned in this report for the preparation of this report.
There is no conflict of interest for RC Capital Management / it’s partners due to publishing this report.
It was the later part of March 2020 and I was really worried about the tail risks to our portfolio. I started getting worried about Covid in late feb/early march and wrote the following posts on it
And the key post in the series: Economic sudden stop in which I wrote the following
What is an economic sudden stop – It is when most economics activities for a location come to a sudden stop due to a financial or natural disaster. In most cases such sudden stops are local such as due to a flood or an earthquake.
Global sudden stops are extremely rare and have happened only during the great depression in 1930s and 2008. Even during wars, we do not have such a situation.
The current crises has the potential of an economic sudden stop (and may have started). I have been thinking of this risk (which I have been referred to as a Tail risk). Over the weekend, I drew the following crude picture to illustrate my hypothesis (please excuse my drawing)
In view of this risk, I decided to analyze all my positions for bankruptcy risk. I wanted to assess how long the companies in my portfolio would survive, if there was complete stoppage of business (revenue = 0)
I am attaching the analysis below. Please note all companies in the note are for educational purpose only. Also we don’t hold these stocks now.
I am sharing an edited note, we published to subscribers recently. A few points to keep in mind as you read this note.
I have a terrible track record in forecasting business cycles.
I got the real estate cycle wrong the last time when we added to the sector in early 2017.
That said, I am stubbornly persistent. Even if I got it wrong the first time, it does not mean I will not try again.
I wanted to start the update for this quarter with some broad comments for the sector and how it is influencing our decisions for this basket. I am looking at the real estate basket versus individual companies, in the same manner as financial services/banks.
The real estate sector is a longer duration cyclical sector like infra in comparison to the financial sector. The real estate cycle is around 8-10 years from peak to peak versus 2-3 years for financials. Again, this is not an empirically proved number, just an observation.
The Indian real estate sector went through a longer down cycle this time due to some additional events namely Demonetization in 2016, Credit down cycle in 2018 and then covid in 2020. At the same time, demand for real estate is usually steady over the long term. There are sub cycles of extra demand from investors, but over the long run demand is tied to household formation, migration, and replacement of old stock.
We had an overinvestment phase from 2003-2010 which peaked around 2011. Since then, we have had a bear market for 11 years during which the excess inventory was absorbed. I had originally estimated that the cycle would turn in 2017 but got the timing wrong (by only 6 years!)
We are seeing an upcycle now. Keep in mind that this cycle will not be a linear one. We could have intermediate downcycles within this secular uptrend. This trend is now visible across the sector as follows.
All real estate companies are now reporting high double digit pre-sales. This will translate to higher reported sales in the next 2-3 years.
There is a trend towards higher priced housing. Increasing pre-capita income level is driving this trend.
Regulatory and other changes mean that the organized sector is capturing incremental demand. This means industry consolidation, better pricing, and higher ROC in the long run.
My gut feel (Which can be wrong) is that we are in the initial phase of this cycle, and it can continue for 3 years or more. At the same time, there will be periodic corrections as we go along.
Our investment in this sector is based on the above thesis. We are spreading our bets so that we can benefit from the tailwinds without being 100% right at the company level. We may swap positions based on the relative performance of the companies in the sector
We posted the following to our subscribers recently. Thought of sharing it with a wider audience
There was a question from one of the subscribers to which we responded via email. we wanted to share the communication with all of you. We have slightly edited the conversation and added to it
Question:
I am fully invested into the model portfolio stocks currently, will I get any panic alert to liquidate portfolio and raise cash and wait for a dip again. Is that how your investing style works or I stay put and be invested at all times. Asking this as, most stocks are trading at all time highs. Is it possible to buy cheap and sell high!?
Our response
We think the underlying question is about timing the market and if we cannot time it, then what will be our course of action? Will we sell in panic to raise cash or just stay put and live through the rollercoaster ride
For starters, we cannot predict the stock market and so can no one else. We have spent 25 years looking at all kinds of systems and approaches and there is none which can predict the market. Some approaches can alert you to the possibility, but there is no fool proof system. If one exists, it is unlikely the practioner will ever share it.
The second part of the question is about a sudden crash and panic selling in response to it. The only scenario where everything just collapses and requires us to liquidate the full portfolio is if a major global catastrophe occurs. Unfortunately, no one can predict or prepare for it.
We have never seen a market where everything collapses suddenly. The worst case was covid which took close to a month to play out.
So how should we navigate this risk if we cannot predict.
We have a defined process to manage risk at the portfolio level and at the risk of repetition, let’s go over it again.
Being diversified: We have 20+ positions in our portfolio with no position exceeding 7% and sector allocation capped below 15%. A collapse in a stock or a sector will hurt us, but not wipe us out
Avoid leverage in the portfolio including F&O: No one can force us to sell
Have sufficient cash: This is not part of our advisory, but 101 of personal finance which all of you should practice. Have proper equity allocation based on your age, and risk tolerance and enough cash to cover personal expenses for 6 months
Stop loss on all positions: This acts as a circuit breaker at the stock and portfolio level. If the stop loss is hit for a stock due to company, sector or market related reason we will exit from a risk management standpoint. We will cap our losses and look for reasons at a later point. These stop losses are reviewed monthly and in advance so that we don’t have to make decisions in the heat of the moment
Our approach is to buy and hold each position till either of these conditions are met.
Stock becomes extremely overvalued, and we decide to cut position size to manage risk.
Company level issues occur and causes me to lose confidence.
Stop loss gets hit for obvious or unknown reasons.
A better idea comes along.
In summary we have a process laid out to manage risk level in the portfolio via diversification, position size and finally stop loss so that we don’t have to predict what will happen. As we cannot predict, our only option is to react to what is happening and if a dire situation occurs, we will do what needs to be done
“It’s not supposed to be easy. Anyone who finds it easy is stupid.” – Charlie munger
Investing is very easy when you are investing in a bull market. If you are ‘unlucky’ to begin investing in a bull market, you start dreaming of being the next Rakesh Jhunjhunwala or Warren Buffett
I used the word unlucky on purpose because every new investor who starts investing in such periods gets a rude awakening in the next bear market
Bull market stories
A common theme during such periods are stories we hear from people who are striking it rich at such times
US covid Tech boom
“Buy quality at any price”
“Chor bane mor”
Secular growth of financial services
Perpetual growth in Infrastructure
The last one was in fashion in 2006-07 when a lot of current investors were not around
What happens at such times is that investors fit a story to the price action and think of it as a law of physics. These stories gain prominence as more investors get sucked into it. Eventually the trend runs its course and a lot of investors are left holding the bag when it eventually turns
Beating the market appears deceptively easy
Can you think of any activity in life which pays well, is competitive in nature and easy all time ? Is it easy to be a doctor, architect, actor, chef ?
Investing seems to be the only field where a lot of people get fooled into thinking that its easy. The reasons are not complex to understand
For starters this is a probabilistic field with returns accruing in spurts. A 15% CAGR over 10 years is not spread evenly over this period. Its more like +25%, +10%, -15%, + 18% and so on. Anyone who invests during a bull market thinks of it as normal and tends to extrapolate it
During such bull run making money appears to be easy. Just buy whatever is in fashion and it works. No need for any kind of risk management
Its easy to trade and getting easier by the day. Open an account in a few days and start trading in F&O. A thousand rupees is enough to get started. There are no qualifications or gate keepers to stop you
Performance over the cycle
Anyone can be a bull market genius. The true measure of performance is over multiple cycles which include several bear markets
Most investors get washed out after a bear market, never to return back. The few who stick around, dig deeper and learn the craft of investing. Even so, this does not assure you of above average performance
The reason for it is that the basis of out-performance changes over time. What worked in early 2000 does not work now. As I look back on my old posts up until 2013/14, it was easy to buy good quality small and midcap companies at cheap prices to make multi-bagger returns. That game is over now
In the same manner, quality at any price worked in the 2015-18 period, or loss making tech companies were the go to place in 2020. A lot of investors tend to stick with the old theme even when the paradigm has shifted
Beware of the snake oil salesmen
If you want to do well over the long run, you have to overcome your natural biases which trip most investors. One has to un-learn and relearn every 3-5 years as the paradigm shifts. If you miss one, then be prepared to live through a period of under performance till you adapt to the new one
That’s the reason why a lot of successful long term investors have said: Trading or active investing is a tough way to make easy money
I can vouch for that. I have worked in the corporate world and invested actively at the same time. I can tell you that making a living from the stock market is much more difficult than a full time job.
So anytime someone tries to tell you that beating the market is easy over the long run, keep these points in mind
They are trying to sell you something which is not worth buying
I am most proud of an investing decision I made years back.
Let’s go the beginning.
I have been investing for last 20+ years. In the initial years, I was fumbling in the dark and trying figure it out. I had several failures and lost a decent portion of my tiny net worth. Over the years as I gained confidence, I started investing more of my net worth in stocks and moved out of mutual funds entirely by 2009. I launched the advisory in 2011 after investing my own money for 10 + years.
During the initial I did not invest a single penny of my mother’s money as I did not want to risk her hard-earned savings on my trial and error. However, by 2011, her savings were dwindling as inflation was eating into it. The interest on her savings were barely enough to cover her expenses and at that rate, she would have run out of money in the next 7-9 years.
Now you must be thinking – That’s what kids are for. I should be taking care of her to which I wholly agree. However, this line of thinking misses a key point – Independence and choice.
Fear of markets
Our parent’s generation is over cautious and conservative. They consider the stock market to be a risky place and media doesn’t help the cause. As a result, most of them invest mostly in fixed income. In doing so they take on a different risk – loss of purchasing power due to inflation.
This fear may not be rational, but you cannot blame them for it. In the 80s and 90s, the Indian stock market was poorly regulated with brokers often cheating their customers (it happened to me a few times). No wonder the earlier generation has been wary due to the speculative cycles and poor regulation of the past.
Instead of wishing the problem away, I tried my best to give psychological safety to my mother when I decided to invest for her
This is what I did in 2011.
Invested 50% of her net worth, same as my own/ advisory portfolio.
Reduced the withdrawal rate from her accounts to bare minimum and covered the balance.
Have not withdrawn anything from the portfolio and let compounding do its magic.
Promised to backstop her portfolio. I would cover any losses personally.
The last point was the key. It ensured that she would not lose money if I made poor decisions.
In the last 12 years, her equity portfolio is up 13X and is 80%+ of her net worth. The dividend income alone can cover her expenses.
There is a joy in having enough money of your own so that you don’t have to depend on your children. I continue to take care of her, but my mother knows that she doesn’t need it and she has a choice. She can ‘choose’ to spend her ‘own’ money as she sees fit. It’s a different point that she has limited needs and spends most of it on her kids and grandkids.
I cannot be prouder of this achievement. I can sense the satisfaction she has from knowing that she has enough to spend as she wishes and not depend on anyone.
If you have older parents, I suggest putting at least a small portfolio of their net worth in mutual funds (if you don’t invest directly). At a minimum, this money would act as an inflation hedge.
However, remember to manage their fears and caution about the stock market. Preferably, start small and earn their trust over time. Finally, be conservative and risk averse with their money.
Believe me, in 10 years you will be glad that you convinced them to do it.
In my 2022 year end note, I spoke about some changes in my approach and using stop loss to manage the risk.
These changes are by design and have not been done lightly. I have always resisted chasing performance based on the latest fad of the day. However, my failures with a few positions such as PEL, Edelweiss and Shemaroo made me question the process and look for my blind spots.
When these positions declined, I dug deep into the financials and thought a lot on it, but could not find a clear way to answer the question – do we sell or hold? The numbers looked good and so we held. It turned out that the market had already anticipated the collapse in the earnings.
That has led me to a 3+ year journey of understanding technical analysis, momentum, factors in investing and so on. As I have studied these other areas, I have adapted my value approach to fit the changing market structure.
10-15 years back, markets were slow in responding to earnings miss and business cycles. These things have changed considerably now. Markets react much faster now – mainly due to higher competition and automated algorithms. In effect the time horizon of markets is shifting.
I have now blended momentum and Technicals to my value style. The core focus on value and long-term value creation remains, however, momentum sometimes acts as a booster and Technicals are more like a trip wire to alert us
Purity of style
I have practiced value investing for 20+ years now. I used to wear it as a badge of honor and made it a part of my identity as an investor. Even my blog is titled valueinvestorindia.com
It is time to go beyond that.
I am not talking about switching from a long term buy and hold to swing trading. However, being religious about my approach is not the way forward. I have belatedly realized that other approaches to investing have their own strengths & weakness and adapting some of these strengths to our style strengthens it.
For example: Risk management is a strong point of successful traders and blind spot for buy & hold value investors like me, who believe in holding a stock forever irrespective of losses.
In a similar manner, momentum/quant investors have simplicity of approach in their favor. Their approach can be boiled down to a few bullet points and easily automated. Value investors like me have layers and layers of complexity. I have used this mindset to strip away the non-essentials.
For example: Over the short-term valuation and management quality are important but not critical. Overweighing this information, which does not add to returns, means we have missed out on good ideas with a 1–2-year time horizon
Stop loss and zone of action
I spoke about having stop loss for each position in my last update. I review the stop loss regularly but will not share it with anyone. The reason for it is simple – I want to retain the flexibility to change my mind.
There is nothing special about the stop loss. It is based on a blend of fundamentals and technical factors including max loss or downside. In case of long-term holding, the stop loss is wider than a trade as that is a position we wish to hold longer.
As long as the price is above the stop loss and I am comfortable with the long-term fundamentals of the company, I will not react.
We cannot react every time the stock drops or rises a few % points. On the other hand, we don’t want to ignore a 20%+ drop, which we have done in the past. A few % change matters for a swing trader but is noise for us. However, a 20%+ drop means that there is something occurring at the company or sector level and a lot of investors including traders are exiting the stock.
At such points, we need to react and make a decision. Are we ok with holding the stock for an extended period and bearing a much larger loss or should we exit and live to fight another day. On this count my thinking has changed. I would rather take a hit to my ego and come back to the position another time.
Evolution
I rarely talk about the macro conditions. It’s not that macro is not important, but there is already enough noise and drama around it
For example – The fed or RBI decision on interest rates is the same for all financial service companies. What’s the point of talking about it? A good financial institution will figure out a way to work around it. HDFC bank has performed well over 30 years even as PSU banks have faltered. Surely it is not because of the interest rates.
I want to focus on what matters for a company and how it can do well in the long run. In the same manner, I want to do the same for us when writing to all of you.
My investment approach and framework will have a lot more impact on our relative returns than the macro. If the world has a major event, such as COVID, all investors including us will be impacted. Our approach will however decide the level of impact.
I spoke extensively about the evolution of my investment approach in this podcast. You can review it if you are interested.
A long-term partnership
We repeat this every time in the portfolio review and will do so again (more for the benefit of the new subscribers)
We do not have timing skills and cannot prevent short-term quotation losses in the market.
Our approach is to analyze and hold a company for the long term (2-3 years). As a result, our goal is to earn above average returns in the long run and try to avoid losses during the same period.
Despite our best efforts, we will make stupid decisions and lose money from time to time. We feel the same pain as we invest our own money in the same stocks.
We will treat all of you in the same manner as we would want to be treated if our roles were reversed. This means that we will be transparent and honest about our actions even when we have made a mistake.
Disclaimer – Stocks mentioned in the above note are for information / illustration purposes only. This is not a Buy / Sell recommendation.
Let me share two personal stories, one recent and another from 25 years ago.
I have a relative who recently passed away at the age of 50 due to a heart attack. He had a very stressful job and was facing financial pressures as well. After losing his job, he found himself short of money, and it seems (though I don’t know for sure) that he thought an easy way out of his financial troubles would be to trade in the stock market.
He lost his savings and sunk deeper into debt. I am certain that all these stressors took a toll on him.
The second story is even closer. This is the story of my own father, who passed away around the same age as this relative. I have shared this story here. He lost money with a plantation company, and when I visited their office, I was told that the money was gone. I can never forget this episode in my life.
Have a Heart
I recently posted a tweet when a bank in the US collapsed
If one invests in a ‘teak’ company or in the stock market, the person may have some idea that they are taking a risk. However, when a depositor puts money in the bank, they are NOT putting that money in with an upside
I received a few replies back, saying that such people do not deserve to get their money back if they did not analyze the bank’s financials before putting their money in. I have analyzed banks for 25 years and am sure that I know more about banks than these folks. Barring a handful of analysts or insiders, no one, including the top management, can tell you with certainty that the bank will not fail.
You have to be a heartless !@@### (insert your choice of word here) to make this statement.
I have been very numbers-driven throughout my investing life. However, there are areas in life where I draw a line. The safety of a person’s life savings is one of them. You can never understand the despair of a person who has lost his life’s savings
Implicit trust
There are vehicles such as bank FD, government debt, Debt mutual funds etc which have an unwritten safety/guarantee implicit in them. If you make every depositor or investor read the 100 page prospectus or study 10 years of financial statements, the system will come to a grinding halt
Our world works on implicit trust and not everything can be driven by contracts or due-diligence. Do you check the safety certificate of a plane or its maintenance manual before boarding a flight. We implicitly trust the system to make flying safe for us
If a plane goes down, we don’t blame the passenger for it
Even if you don’t consider the humane aspect, you will realize that if you do not the guarantee deposits, the whole system will collapse
Don’t believe me? read about the banking failures of last 100 years and you will understand why regulators and government rush in to protect depositors. Hint: they did not in the 1930s and that led to the collapse of the US economy
Are more regulations the answer
There are a lot of regulations from SEBI, and these keep growing by the day. My partner, Kedar, carries all the burden, and it is tough to keep up. However, considering the number of bad actors and terrible advice on social media, I personally think that’s a small price to pay (for people like us)
Bad faith investment advice and get-rich-quick schemes are not harmless gimmicks. They cost lives and destroy families.
