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  • Shobhit Khare

Why booking loss could be more profitable than booking profit...

Let's consider an example to understand this better: Imagine that you are preparing to go on an uphill drive with a slope to confront. You have two choices - 1) A high quality sports car (let's call it Car A) and 2) A refurbished car with attractive exteriors but a really dodgy and unreliable engine (let's call it Car B).

The situation in equity investing is not very different from this hypothetical travel choice. Commercial enterprises always have challenges to overcome which can be compared to an uphill slope. The companies are themselves similar to cars trying to navigate the uphill and the investor is a car passenger who has to decide which car to take. Most people can easily decide that Car A is a better option as it will be faster yet safer and will offer a much more comfortable ride. Car B will run erratically, the engine might fail frequently, and hence will most probably spoil your travel. Some times, when the engine and brakes have both failed, it will travel in the reverse direction and be lethal for its passengers! All in all, I am sure you would agree that Car B is worth avoiding even if offered for free!

Coming first to the question of 'profit booking'. Suppose Car A has already travelled quite a distance and is cruising along well with no foreseeable barriers ahead. Should one then abandon it (aka profit booking) just because you have already travelled a good distance in a short time? Or would you instead commit yourself to Car A even more, now that you know about its solid performance and hence are more confident about it? Assuming that you are still interested in travelling further, it would probably be better to continue with your high performing car while at the same time undertaking regular maintenance check-ups. Remember that commercial enterprises have lives spanning from decades to centuries and don't really exhaust themselves in a year or two. This means your right stock investment can take you much much farther in this journey of wealth creation and 'profit booking' might have an enormous opportunity cost. Your account statement will never show how much money you never made because you sold too soon even after spotting a good opportunity. However, let's make no mistake - any such loss would be as real and probably more painful!

Now let's talk about 'Not selling at a loss'. Note that here we are talking about clear cut investment mistakes and not a temporary decline that even good stocks frequently go through. Generally these mistakes can happen because of two reasons: 1) During an intermittent period of trouble free travel, you mistaked a Car B type investment as Car A type, or 2) You never thought about the long investment journey ahead and opted for Car B because it was available at a 'low price' and looked 'hot' from outside. Long term results will be similar whatever the reason for selection: Car B will drain you financially and emotionally, might take you several miles backward rather than forward (remember the upward slope!) and can be very detrimental for your overall well-being. Except for a planned adventure thrill, we can't think of any other reason to opt for Car B. Once in, and knowing you are in the wrong type of car, what would you rather do? Stay back hoping that it takes you at least where you started? While miracles do happen sometime, it would be foolish to depend on them as the strategy to succeed! Only more setbacks and nothing else is in store for any one hoping against hope. The sensible option in this case would be to abandon Car B and look for Car A type of investment, no matter where you are (ahead or behind the original starting point).

To conclude: there could be huge opportunity cost associated with 'profit booking' and significant future gains can be made by admitting an investment mistake, selling at a loss and deploying those funds in the right stocks...

In investing, most of the risk comes from within the investor rather than from outside environment. Selling your winners while embracing your losers is a sure short way to say good bye to the riches. Still most investors do that and to top it, think they did the smart thing!

At Inertia, we remain cognisant of these issues. While we are not complacent, We embrace our winners? And while we take utmost care when adding a new stock, we don't shy away from acknowledging a mistake and cutting our losses as soon as we know we boarded the wrong car. While doing so, we are guided by the fundamentals rather than price movements...

Inertia portfolio is akin to the fleet of best quality cars around. Once boarded, continue with us on this exciting path to wealth creation we have embarked. Wish you a happy journey!

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