Despite correction in December, Indian equities have ended 2021 with stellar numbers. For most of the year stocks rallied, and both the benchmark indices scaled new highs. A significant part of the rally was driven by large-cap stocks, many of which have reached record highs. The NIFTY 50 index, a collection of 50 large cap stocks on the NSE, has grown by 22.8% from 14,018.5 on January 1, 2021 to 17,203.95 on December 30, 2021.
In past there have been many stocks that have either remained stagnant or corrected and did not recover for years after reaching a peak. So, if you have investments in large-cap stocks that have rallied during the year, should you continue holding them? As an equity investor if large-cap stocks makeup a good part of your portfolio then the timing of exit from a stock becomes crucial.
Here's how you should evaluate if right now is the right time to make an exit from a large-cap stock.
If you have reached or are close to your goal
The most obvious reason to exit from a large cap stock is when you have either achieved your goal or are very close to it. Even if your goal is 1-3 years away but you have reached closer to it, say around 90% of the intended value, then this could be a good time to make an exit. The equity market is known to be volatile and if there is any correction going forward you may not be able to recoup the gains made within the limited time left. So, it is better to preserve your gains by making an early exit. You can shift your proceeds to safe avenues like liquid funds or fixed deposits. If you do not want to exit in one go then you can do it gradually, reducing your equity exposure regularly within the remaining period.
Corporate governance issues
When a company grows in size it becomes difficult to manage it without a well laid out system and processes. Above all the values which top management demonstrates become a deciding factor about long-term sustainability of the company. If a large company falters on governance, it cannot survive for long. The examples of Yes Bank, Satyam Computers and Reliance Communication gave us a hard lesson about the fact that corporate governance is the one of the major factors that can make or break a large cap stock.
"A major red flag to exit a company is when there starts developing corporate governance issues in the company and there are no actions being taken to correct them. Even though in bull market, sometimes these things are ignored, but once the negative trigger is activated for the stock, the same can be like a falling knife and it becomes difficult to get a timely exit," suggests Tarun Birani, Founder & Director - TBNG Capital Advisors.
There are many symptoms which will tell you about the problem with a large cap company. "If company is having fluctuating financial results, integrity of management/promoters in question, taking operating or managerial decisions at the expense of investors only benefitting top management then, it is advisable to exit from these companies at an appropriate price," says Rajiv Kapoor, Vice president Trustline Securities.
Consistent underperformance in profitability
The return for an equity investor largely depends upon the growth in profitability of the company. While the net profit number remains an important metric to evaluate a stock, but it is the operating profit of the company which gives you the clear indication about how well the company is running its core business. If the company is posting poor profitability numbers consistently for many quarters, then it could be a trigger to start considering your exit from such a stock. For instance, Coal India' profit number has hardly grown over years which is also reflected in its share price movement. After being listed at Rs 245 in 2010, it is currently trading at around Rs 146.
Headwinds beyond profits
For a large cap company, the next level of growth always remains a challenge. So, any signal of stress that can hamper its growth should be thoroughly investigated by investors. While profitability is one of the most important factors that decides the fortune of a stock, however, there are many factors beyond it which the investors need to evaluate.
"Along with the profit, it is also important to keep your eyes on changes in company fundamentals, stagnancy in topline and bottom-line, changes in industry scenario and competitive intensity and also failure to innovate new products and services," says Manish P. Hingar, Founder, Fintoo, an automated financial planning platform.
When major growth drivers start showing sign of weakness it is also a signal about future trouble. "One can consider exiting a company when the company is not able to grow its revenues and marketplace of the company looks increasingly competitive with potential for declining margins. And in such scenario, if a company fails to effectively counter with new growth plans which could improve its growth," advises Narendra Solanki, Head Fundamental Research- Anand Rathi Investment Services.
One sector which has seen its fortune crumble because of rising competition is telecom with the Vodafone Idea stock getting crushed due to price war led by Reliance Jio. So, rising competition in a particular segment could be a good trigger to evaluate your stock for exit.
If the stock prices are stagnant despite good financials
A company may be delivering good financial numbers but despite that it may not see corresponding rise in the share price. While numbers may hide the internal issues, but the market will soon start factoring in any potential pitfalls. "If the future growth is curtailed due to some industry headwinds or company specific issue, market will start pricing that at the earliest regardless of what the present numbers indicate," says Birani. For instance, NTPC has been posting good financials but its share price has hardly grown over the past 10-12 years.
Negative government policy
Government policy plays a major role in fueling or stymieing the progress of an industry or sector. So, any development on the policy front which may affect your large cap investment, needs to be carefully examined. "Negative government policy is one factor which can help you decide to exit a stock. For example, ITC which is not performing due to negative stance over tobacco is running ahead of earnings," says Nitin Shahi, Executive Director of Findoc, Financial Services Group.
When cutting your exposure or partial exit makes sense
Some stock may have done exceptionally well and there could be future potential too but if the valuation is extremely high you can consider cutting your exposure and making partial exit. "Higher profits would indicate good financial performance by the company. But when Mr. Market demands a price that values the company much more than the underlying fundamentals, that is the time when an investor should trim their holdings," says Nimish Shah, CIO - Listed Investments, Waterfield Advisors.
While there is no hard and fast rule for a valuation cut off that can be said to be high, but an exorbitant premium may be a sign to consider trimming your exposure. "Dmart is trading at 100 P/E which is quite exceptional. Earnings may catch up in future but there may not be price surge as it is already trading at premium valuations," says Shahi of Findoc.
When not to exit
Not every small sign of stress or stagnation should make you consider an exit from a large cap stock. "Investors should not make a total exit from a good quality company if they have bought it as part of the core equity portfolio. Market cycles and sentiments could show attractive profits on good quality stocks," says Shah of Waterfield Advisors.
If you make exit on impulses, it may be difficult to re-enter. "A complete exit would negate the decision taken to participate in the long-term growth of the company. Generally, due to a heuristic bias, it is difficult to re-enter a good quality stock (that has been exited) if the prices do not fall to the extent expected when taking a full exit. So, if you have bought a good quality business and its share price sees a sudden spurt, trim only to the extent of profits and hold on to the core amount invested," says Shah of Waterfield Advisors.
Big scale should not always be a factor to exit
Exiting a large cap stock only because it has grown too big and that it has already delivered a big return may not be a great idea. "From experience one thing which an investor must understand while investing in India is big brands become even bigger. Selling a stock is a difficult task. Take an example of Bajaj Finance, where experts had a negative view on the stock and even downgraded it during Covid, however, the share price witnessed a massive rally outperforming the markets," Shahi of Findoc.
