You stand in a queue in a supermarket to pay your bills, if another stranger tries to jump the line you are bound to get upset. This is because you believe you own the place in the line. This belief is called anchoring in behavioral economics.
When we buy a stock at a certain price, the investor gets anchored to the price at which he has bought the stock. All the future decisions of the retail investor get anchored to the price. Under the normal practice of the investor, if the price drops significantly he or she will not sell the stock and switch to a more profitable investment. They wait for years for the stock to return its original price before selling the stock.
The investor would have been better off selling the stock for a loss and investing the same when in a different stock or asset class.
Let us take the example of one of India’s most respected companies Tata Steel. The stock traded at ₹939 in January 2008. The company had acquired Corous by leveraging its balance sheet and borrowing several billion dollars.
In 2008 when the world financial markets collapsed the price of Tata Steel plummeted to ₹166.50. If the investor instead of staying anchored to his position in Tata Steel had sold the stock and booked a loss of ₹773 and switched his funds to JSW Steel, a company in the same sector the stock adjusted for a split would have been available for ₹22.16. An investor could have bought eight shares. The stock is currently trading at ₹194, while Tata Steel is trading at ₹492. The investor who stayed anchored with Tata Steel would have lost ₹447 till date. A person who made the switch to JSW steel would have seen his investment grow to ₹1,552. He would have made a profit of ₹613 on his initial investment of ₹939.
This calculation discounts the dividend earned in both stocks. The result would have been more spectacular if the investor had moved to another sector. The moral of the story is that the investor must remain anchored to the fundamentals underlying the stock they have invested in rather than the price at which they bought the stock.
Even though Tata Steel is a better run company, with better corporate governance the huge debt accumulated by the company altered the fundamentals. The stock will take another decade before an investor anchored at his entry price of ₹939 is able to exit at a profit.
Markets are fluid and fundamentals can change dramatically.
A smart investor must know when to drop anchor and when to lift the same to enable him to sail in the high seas in search of better port to drop anchor.
( The writer is an author & consultant)