How to Deal with Companies in Trouble

Lately, many Indian companies have run into trouble. From those belonging to the NBFC sector to the ones hit due to poor corporate governance, the list is long. Unfortunately, many investors (including myself) have had to bear the brunt. Can an investor preclude investing in such companies?

After a scam has been unravelled, business newspapers and magazines are filled with postmortem analysis and how you could have avoided the impacted companies. But that’s all with the benefit of hindsight. Even if someone reliably predicts a troublesome company, how do you distinguish his analysis with the countless other analyses and propaganda against companies doing the rounds. In my view, you can’t always avoid investing in a stock that will turn a nightmare later on. This makes your post-crisis strategy important.

The first leg of your post-crisis strategy actually happens when you make the investment. Invest as per your pre-decided allocation strategy. Don’t go overboard with investing in just one company, no matter how promising it appears and how attractive it has become. Secondly, avoid buying more when the stock price has started to crash. Thirdly, avoid the temptation to sell away (unless you are in profit or making a small loss) just because some news has broken out.

Now the core of your strategy. You are invested in a company that’s caught in some trouble and your stock is already down significantly, say above 25% or, worse, 50%. What should you do? Avoid acting on media reports and wait for more clarity. Media tries to sensationalise things and hence its reporting will likely be nothing short of a doom prediction. Also, media is hungry for developments like these so that they can fill pages. If you sense that there’s indeed some trouble, try to measure its impact and timeline. If some problem is going to be over in the next six months, you might like to hold the stock.

What if you still don’t have clarity but the stock keeps falling? In all such cases, it’s better to start exiting in lots. If  it’s a big holding, it can be sold over a year. Smaller holdings can be sold between three to six months. By selling in tranches, you still stand the chance of benefiting from a recovery, which looks elusive when the crisis happens. The impact of the loss also gets distributed. Above all, you save the remaining capital from getting destroyed.     

In India, especially in recent times, stocks that faced some trouble have been thrashed to such an extent that a recovery looks impossible. It’s natural for the investor to lose hope. Just formulate a post-crisis strategy and stick to it. Over the long term, if your overall stock selection is good, such losses are neatly absorbed by the gains.