A yearly high does not mean much in the long term for investors.
As bellwether indices hit a new high, most investors see it as time to rejoice. But there are quite a few who want to know as to how long this rally will last. It is very good news for the investors holding the stocks. But amateur investors start wondering if this ’52-week high’ has made the stock an overpriced one. Experts make it clear that one need not rest his investment actions only on the price movement for a day. Instead take a more informed approach. “Look at the valuation of the stock in the light of the changes in fundamentals of the company before taking any decision of buying or selling the stock,” says Vikas Gupta, CEO and Chief Investment Strategist at Omniscience Capital. If the fundamentals are improving much faster than the changes in stock price and the stock is available at a relatively attractive valuation, then there is no point in selling it, he adds.
Overcome Your Biases
Stock prices oscillate and keep making new records. For the beginners, when the stock hits the highest price in the last one year, it is said to be at the 52-week high. A low over a period of one year is called 52-week low.
Many value investors keep a track of the list of stocks hitting a 52-week low to spot an attractive bet. However, all stocks hitting a 52-week high are not necessarily overpriced nor all stocks hitting 52-week low are underpriced. A stock can continue the momentum and keep making new high or new low as time progresses.
If you decide to sell just because the stock you are holding hits 52 week high, then you will miss most multibaggers. For example, you would have sold stocks such as Eicher Motors, HDFC, MRF much earlier had you given undue importance to 52 week high. Experts in behavioural finance term 52 week high as one of the anchors. This behaviour of giving undue importance to such numbers is called as ‘anchoring bias’.
Do fundamentals tell you a story?
If you are worried that your stock will hit its 52-week high, here is what you should do. “Start with the valuations of the stock,” says Vikas Gupta. Check the traditional ratios such as price to earnings, price to book and dividend yield. Evaluate the stock in comparison with its peers. Large divergence may mean red flags, but do not jump the gun. Check the company’s performance quarter on quarter and year on year. If the company has been posting continuous improvement on parameters such as profits, profitability and return on investment, the stock should be in up trend.
“Most individuals are focused on price momentum, but seldom do they track earnings momentum,” says Vikas Gupta. If the stock is up due to fundamental reasons and not because of some short-term sentimental uptick, then the investor should not dump such stock.
In case of a stock hitting 52-week low valuations are typically cheap or they are getting cheaper day by day. It pays to check if the company is reporting signs of a turnaround. If there are visible signs of a change in business environment and the valuations are compelling, one may choose to bite the bullet. While value investors look at 52 week high with a lot of caution, the technical analysts take a different view.
“When a stock is in up-trend and hits a 52-week high, it is seen to be demonstrating inherent strength,” says Pushkaraj Sham Kanitkar, AVP technical research, GEPL Capital. “There is a fair chance that the momentum will continue and the stock will go up further.”
The stock price movement must be seen in the light of the broad market. If the stock hits 52 week high when the broad market also quoting at yearly high, then the stock is moving in tandem with the market. But beware of the stock that hits 52 week low when the market is hitting yearly high. If the overall positive sentiment can’t lift the price of a stock, then there may be something seriously wrong with the stock.
If the stock hits 52-week high with more than average volume, you may see a technical analyst asking to buy more of such a stock. In case of a stock hitting 52-week low with a spurt in volume the chartists may ask you to short sell more of it in anticipation of a further fall. After all, the chartists prefer to be with the trend.
What should you do?You should not go by the urge to ‘do something’ as the stock prices keep moving almost every day. If you find a reason to act, you should buy or sell; otherwise hold on to your position. “When you follow your process of analysis, you will get the answer. If your process tells you to exit a stock at a price point – be it 52 week high, then follow your process,” says Vikas Gupta. There are times when you would sell a winning horse or potential multibagger just because it is overvalued at that juncture. In the hindsight you may repent your decision. But adherence to your investment process will ensure that you will be saved from all those duds that came your way.