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Buying a ‘falling knife’ stock? It’s a high-risk gamble

Author: Kumar Shankar Roy/Wednesday, May 8, 2019/Categories: Exclusive

Buying a ‘falling knife’ stock? It’s a high-risk gamble

The sharp drop in Yes Bank shares has given many bottom-fishers a so-called dream opportunity, but don’t start punching buy orders yet. When Yes Bank shares plummeted 29 per cent on April 30 after a shock loss in Q4, Whatsapp trading chat groups, social media and many market analysts became bullish on the stock. Yes Bank is just an example. Over the last few months, the Indian stock market has seen quite a few names, big and small, witnessing extreme forms of volatility. In October 2018, shares of e-commerce firm Infibeam Avenues fell as much as 73 per cent in one day after concerns related to a message doing the rounds alleged corporate governance. Housing loan firm DHFL’s hit the lowest level since May 2014 as the stock tanked 30 per cent in four days in late January 2019. In late April, shares of grounded air carrier Jet Airways lost 52 per cent in 3 days as lenders turned down a request for emergency funding.

When such events happen, it is quite easy for investors, especially the retail investor, to get attracted to such a stock. Don’t catch a falling knife is an old adage, which turns out to be true on most occasions. Many stocks when they fall by a huge margin, never recover, making those investors who got in late stuck. They have nowhere to go. Retail investors always get into such situations when others sell. If something is cheap and falling in price, there are reasons why is it so. Read to know more.

Understand reasons why stock is falling

Stock investing is not for an adrenaline rush. We know how it feels to do something exciting, but stock investing is a not game. It requires your money, hard-earned in most cases. It requires buying fundamentally sound companies. It requires patience. There is no list of stock that 'will go up in next 5-6 months'. It is a market, where demand and supply decide the price of stocks. Single-day price drops are the most difficult to understand. 

There will always be a reason why a stock falls by 30-70 per cent in one day. It cannot be just like that! For instance, when Yes Bank fell by almost 30 per cent, it was not because suddenly investors dumped the stock because they did not like its name. Even though Yes Bank’s losses in the March quarter of the financial year 2018-19 were not completely unexpected, investors were in for a shock when the new CEO front loaded all the pain in the bank’s books. Many were taken aback at the sheer size of front loading.

When Jet Airways was grounded, so many people thought it is a temporary blip. It is one of the most loved airlines in India, right? Somebody would definitely come to ‘rescue’ it. On April 22, Jet Airways after a punishing over 50 per cent fall in three days was trading at Rs 130 levels. It is May first week already, and the stock is still at those levels. Bottom-fishers who got in Jet stock are having to play the waiting game and there is no clarity on how long will this go on. Do you want to engage in such trades? If you are smart, you know the answer. When an airline with 16,000-employees stops operations, it is not a small thing. The amount of money required to run such an operation is massive. Big money problems need bigger money solutions.

For any retail investor, it is important that there be a good understanding of why a stock is falling like nine pins. If the reason is a one-off, you can still take a bet. If a stock drops sharply one day, the language of the company officials can help you understand their confidence levels. If they are unsure, do not go ahead and be sure of the stock’s revival. Wait it out. Try to find out if the company is starting measures that will help recover. Also, find out what would be the cost of those measures. 

Some troubled stocks recover but...

Many investors will argue that there are many stories about how a stock fell by a huge margin, and has slowly recovered. Yes, such stories are there. They are rarities and that is why they are so interesting. For instance, in the great financial crisis of 2008-09, most Indian stocks fell by huge margins. Do note that there was nothing particularly wrong about Indian stocks at that point. It was incessant selling by market participants. But when a company’s stock falls due to its own problems, the ball-game is different. 

In recent history, we have seen one popular stock tank sharply and then start a slow trudge back. Zee Entertainment, owned by Essel/Zee group, on January 25 had cracked by 26 per cent after a media report talked about investigation for suspected wrongful acts. It came to light that some entities, which had pledged shares of Zee Entertainment promoters, invoked and sold the stock. A mountain of debt was looking ominous for the Essel/Zee group. The promoters of Zee Entertainment conveyed their inability to provide additional equity shares as most of their domestic shareholding was already pledged. Consequently, a meeting was held between the promoters and the group of lenders and it was agreed to provide additional time to promoters to complete their ongoing strategic sale plan of Zee Entertainment shares. In a sense, the Zee company’s promoters have time till September 2019 end to make good on their promise. These developments helped the stock start to recover and the stock is back to pre-crisis levels.

Retail investors should not hope that the story will play out like this every time. In this situation, the lenders and the company management have merely delayed the invoking of further shares until an agreed time. If the promises are not kept, nobody can say with certainty that the invoking of pledged shares will not happen. 

We have seen examples of stocks like Infibeam that cracked by a huge margin and are yet to recover. The stock fell from Rs 200 levels to Rs 80 and then kept on losing ground, and today trades at Rs 40-50 per share range. Imagine somebody buying this stock at Rs 80 and hoping for a recovery. When stocks fall by a big gap, it takes a lot of time for them to recover under usual circumstances. Nobody becomes rich overnight, especially in a badly beaten down stock. Is this the best investment for your money? That is a call you must take after deliberation and discussion.

The author is a journalist with 14 years of experience

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Kumar Shankar Roy
Kumar Shankar  Roy

Kumar Shankar Roy

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1 comments on article "Buying a ‘falling knife’ stock? It’s a high-risk gamble"

Alok Mittal

5/9/2019 5:23 PM

An excellent, well written article.

Worth reading as well as thought provoking !

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