Often investors are told to invest in a fundamentally strong business and then remain invested for a long period of time. However, there are certain situations that demand an investor’s attention and may signal that it's time to exit from the stock. Let’s see under what circumstances should an investor look to book profits instead of remaining invested in a business.
When selecting a good business, we always consider how strong it is fundamentally, or how innovative the business is in its product offerings, which signals growth potential, how it scores over competitors and operating or profit margin. So we basically assess the financial health as well as the viability of products before selecting a business to invest in. Needless to say, exit decisions are also based on the same parameters. Investors should consider making an exit when they see the fundamentals of the business are not as strong as they used to be. To see that, look out for the quarter-on-quarter performance of the company. If you see a delay in reporting of growth numbers of the company, which is showing sustained underperformance, or if there has been an increase in the non performing assets (for banks and NBFCs) then investors must sit up and take notice. Increasing debt is also an indicator that the business is slowing down. Successful businesses that went on to become multibaggers operated on zero to negligible debt. Take a look at the debt market cap ratio. It is a way to measure the debt against a company’s ability to raise capital. An increasing debt-to-market ratio is a bad sign and should be considered while taking exit decisions.
Another important aspect to factor in while creating an exit strategy is corporate governance. A business that upholds strong corporate governance principle ensures that the management takes decisions that are in the best interests of external and internal stakeholders such as employees, investors, partners. Apart from this, the business must be conducted in a fair and ethical manner matching industry standards and must be away from legal and regulatory disputes. Look at the company’s disclosure policy, the executive compensation policy, dividend policies, conflict resolution framework between various internal and external shareholders. This information is disclosed when the company is publicly listed. Follow the news about the company you have invested in for corporate governance defaults. If you see there has been no resolution of ongoing disputes, the management has failed to come up with satisfactory clarifications, hasty exits of key personnel, then it's time you take notice. Many investors wait for an increase in stock prices after such issues come to light and sometimes see this as an opportunity to buy more shares. However, depending on the severity of defaults and how well a company manages setbacks, such issues dent investor sentiments and more often than not, companies don’t command the same respect from investors as before. If you see cracks in corporate governance, you should definitely consider devising an exit strategy.
Many investors who remain invested in businesses for decades find it emotionally difficult to part ways when such incidents come to light. However, it is important to remain rational on money. It is possible that the scrip price climbs up after you made an exit and you may regret not waiting to sell at peak price. However, thinking about it once you have booked profits is a useless pursuit and will only cause you more stress. If you see the stock prices are climbing again, give sufficient time to judge whether you should look to reinvest in the company or not, most importantly, assess the company again according to its current standing and then take a call.
To sum up, as a stock investor, exiting a stock is always a tough decision to make. However, staying with a company even when it has defaulted on fundamental parameters is not wise either as it will affect your profits. Be prudent while taking stock market decisions and take notice of the red flags to know when to exit a stock.
The author is the Co-founder and COO, Groww