How to tell when a share's price may fall

[K.Karthik Raja]

How to tell when a share's price may fall

Instead of rationalising, sell the stock when trouble strikes the
company and reassess the situation from a cooler distance.

"It's different this time" are the most expensive words in the
investment business. They are a rationalization trap of the highest
magnitude, particularly in reassuring yourself to hold on to a share
when it's clearly better to sell it.

Confronting Reality

Although business situations are seldom if ever identical, success in
business can be analyzed; patterns of managerial behavior are
recorded, categorized, and taught in graduate business school classes.
In the same way, there are common contributors to failure which are
discernible in deteriorating investment situations. Following is a
list of some of the danger signs:

Heavy promotion of the stock by management or agents
Projections of unusually strong/lengthy growth
Use of round numbers for predictions (e.g., 50 per cent growth, or a
"$ 10-billion market")
Questioning the motives or expertise of reasonable doubters
Strong claims to being the best, unique or exclusive in a business
Defining the market narrowly so that, by definition, one is the
leader
Ready excuses faulting outside forces when performance falls short
Lateness in reporting earnings (against either prior practice or SEC
filing deadlines)
Change in outside auditors
Change in lead banker without improvement in interest cost and/or size
of credit facilities
Substantial insider selling of the stock
Resignation of key officers or of directors
Sales or margins trends diverging negatively from those of the
competitors
Inconsistent management statements
Identical (seemingly rehearsed) management statements
Stonewalling when trouble is obviously present.
Faced with some combination of perhaps three or four of the above, an
investor can reasonably and prudently conclude that something is wrong
and should get out of the stock. To insist that a particular
combination of adverse events as seen in another situation can be
fully repeated before concluding the stock is in trouble is naive, and
probably costly.

Things do not get better by themselves. When a company's affairs
appear to be deteriorating, even if certain negative events have not
been reported, investors are well advised to assume the worst by
projecting that the situation is likely to continue worsening.

The point is, investors should be looking diligently for disturbing
similarities to other problem situations rather than watching for
comforting differences. The objective is to detect trouble as early as
possible, thereby preventing or limiting loss of one's capital. There
is an analyst's clich� that the first earnings disappointment will not
be the last.

Similarly, be suspicious at the first signs of any type of trouble.
Unless a neutral or skeptical observer can be convinced that all is
well, exit before things have a chance to become worse. Ask
dispassionately whether, in light of today's facts, it is a good idea
to buy now.

There is a real but subtle difference between the "this-time-it's-
different" rationalization and "this can't be happening to me." If
what is going wrong is like something that went wrong once before,
there is probably a reason. Putting it bluntly, the same mistake has
been made again.

Simply hoping that the same mistake could not have happened again,
however, is just across the reality-denial border from "this is not
happening." This indicates a need to deny that anything is wrong, a
blocking of the pain caused by a mistake. And, of course, when a
mistake is public knowledge (the broker knows, and at year's end the
tax accountant will know, too) the distaste is all the more deep and
embarrassing.

What usually happens in these situations is that the investor focuses
in the wrong direction; he turns subjective and inward. But the
reality is that whatever is happening (collapsing earnings, a dividend
cut, executive stock sales or resignations) is happening to the
company -- not the investor -- in the objective plane, entirely
unconnected causally to this particular investor's current ownership
of the stock. It is happening, period.

The personal internalization that says "it is happening to me" and
eventually "this can't be happening to me" is a rationalization.
Sometimes an investor grasps at the discernible differences from a
disastrous past investment experience and uses them to tell himself
shakily that it will be alright, it is not at all the way it looks.

Instead of rationalizing, sell the stock at the point in time when
trouble strikes the company and reassess the situation from a cooler
distance. Remember that things do not right themselves. And realize
that some serious buying power from other investors will be required
to get the stock back up to higher levels.

A smart investor asks this key question: If I did not own the stock,
with today's knowledge would I be a buyer now? When trouble first
appears, prepare for the worst. This includes developing a mental
scenario of what other shoes might drop, how long it all will take to
play out the situation and how the market will react to the problem.

The most important aspect of performing this mental exercise is to
examine prior situations in search of their similarities rather than
differences. Then from a big-picture standpoint, remember that history
does repeat.