Few things get the market as enthusiastic as the emergence of a “hot stock”. There is a sense of excitement at discovering a new company. Suddenly there are various articles and stories floating around as to why this stock will be the next big thing.
Some investors are attracted by its growth thus far, some by its potential, some because the momentum is strong with it — and still others who want in because everyone around them is talking about this stock.
Many rational notions initially take a backseat when the market discovers such a new romance. Everyone wants in, and most are happy to pay whatever is being asked.
But, while the market may be susceptible to bouts of euphoric love for certain stocks, it’s definitely not blind every time - only a few such romances blossom into a long-lasting relationship for investors.
Many receive a reality check and trade at sobered down valuations, some fade away over time — but the worst nightmare is when these hot stocks melt.
Once the market swings from love to “fear”, investors want to get out of it at an even faster pace than they wanted to get in. This is usually driven by idiosyncratic events that result in a loss of confidence in the management/company - corporate governance issues are often the main reason for such a dramatic loss of trust, though negative surprises like poor earnings or dividend reductions can also sometimes engender similarly devastating results.
The stories and reasons might be different, but this trend happens more or less every year, and 2018 was no exception. Let’s look at 5 ‘hot stocks’ that melted in 2018, and what can we learn from them.
After seeing its share price almost triple in 2017, market darling Vakrangee saw a steep decline in its fortunes in early 2018 after rumours that SEBI was investigating the company for alleged stock price manipulation.
The company sought to restore confidence by announcing a large buyback and dividend program - but it only deepened its crisis when they later canceled this amid poorer than expected results. Today, it still remains out of favour with investors and has lost more than 90 percent since the start of 2018.
Vakrangee’s fall from grace triggered the collapse of another market favourite, amidst speculation that the promoters of PC Jewellers might have held back information on a business relationship with Vakrangee.
Later in the year, reports surfaced that promoter Padam Chand Gupta had gifted some his stake to family members via undisclosed off-market transactions.
Similar to Vakrangee, the company announced a buyback in an effort to boost market sentiment but resulted in further agony for investors when they cancelled it after just a few months.
Another classic case of a hot stock melting is Manpasand Beverages, which has lost 80 percent of its market value in 2018. The key trigger that led to the downward spiral was the abrupt resignation of its auditors Deloitte Haskins & Sells in May.
This triggered speculation around possible accounting fraud - and while nothing has been proven yet, investors have continued to shun this one-time favourite
Dewan Housing Finance (DHFL)
The aftermath of the IL&FS bankruptcy fiasco consumed a one-time market favourite in DHFL. In just one day in September 2018, the company lost 60 percent of its market value amidst rumours that its books had large exposure to IL&FS debt and that DHFL was facing a looming liquidity crunch - this was exacerbated by news that DSP mutual fund had offloaded a chunk of the DHFL issued commercial paper it held.
While the management has repeatedly claimed the company is in good financial health, the market remains jittery and the stock remains down 60 percent YTD
Gitanjali’s fall from grace has 2 main chapters. The first was in 2013 when SEBI announced it was investigating its promoter Mehul Choksi for market manipulation and related irregularities - the firm’s market value eroded by more than 80 percent that year.
The company (and market) adjusted to this new reality, and for 4-5 years the stock bounced around in volatile range - until earlier this year when the Nirav Modi scandal broke out and engulfed Gitanjali Gems as well.
Since then, the market has completely written off this firm and today there remain no buyers for this stock even when it’s trading at Rs 1.
Investors often come across statements like “If you had invested Rs. 100 in Infosys 10 years ago, it would’ve grown to Rs. X”. This is a very common way to highlight missed opportunities, the power of compounding and attempt to inculcate long-term investing behaviour (and other habits).
The problem with such an example is that it only provides an incomplete picture - and one that can only be painted with the advantage of hindsight.
Having this knowledge with the same level of confidence 10 years ago is something that even most professional investors will agree isn’t possible.
And secondly, for every Infosys, Reliance, or TCS there are firms like Gitanjali Gems and Manpasand Beverages — companies that were at a similar growth stage as these giants were 10 years back, except they then got engulfed in corporate governance scandals that hit them hard.
Many retail investors lost their entire savings after investing in such hot stocks. While such stocks can be very rewarding, investors should remember the benefits of diversification and how doing so can shield their overall portfolio - this is something that institutional investors do without fail.
For example, Morgan Stanley owned more than 5 percent of Gitanjali Gems at one point. Yet after the stock crashed, Morgan Stanley didn’t get burned because their overall portfolio was diversified across many other investments.
Retail investors should apply similar measures when investing in equities. They should either look to build a diversified portfolio of various single stocks, or invest in readymade equity portfolios that contain the companies they like - be it via mutual funds, ETFs, or smallcases.
(The author is co-founder and Head of Investments, smallcase technologies.)Disclaimer: The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.