The Thoughtful Investor
When To Catch A Falling Knife And When Not To?
In this section the author tells when to catch falling knives and when not, along with a detailed explanation of the importance of the company's and sector's quality when catching these falling knives.
The author categorizes stocks into three groups.
- In a low-quality industry, a high-quality company (Infrastructure). Voltas saw its stock price move down hitting the bottom despite having good financials, and then recover equally fast.
- A high-quality firm in a high-quality industry (consumer). Titan Industries, is one such company where the author took position in 2008 after it fell to almost 50% from the highs, the author basically wants to convey that A high-quality company in a high-quality industry won’t fall much beyond a point.
- A low-quality company in a low-quality industry (Real Sector). Unitech started falling as the fundamentals started deteriorating with each passing quarter.
The last one should always be avoided by investors because it has the greatest potential for harm. When the fundamentals begin to deteriorate and when the retail investors begin to rationalize it, having a part-owner mindset can backfire and cause one to not sell.
The author had taken a long position in Voltas, which was now falling in value. So he used to go on long walks and count the number of Voltas AC in his neighborhood which gave him the assurance not to sell. However, he made a mistake when he realized that AC contributed only 30% of the company's revenue. After a high growth company begins to slow down on the growth curve, it rarely returns to the high growth stage.
High-quality stocks are rarely cheap, so trying to buy them at a discount is a strategy that rarely works as well as it is debated. Believers in a story typically enter early, before the bottom, and must bear the pain before the gain.