Good businesses seldom trade at bargain prices. However some times, very rarely, they are struck by adversity that hurts earnings. In our experience the immediate price reaction to any sudden negative development for good business is mostly negative. If on a calm analysis we can conclude that the hardships are temporary and less impactful than the price has discounted, such bloopers can be a good opportunity to pick good businesses at good prices.
The obvious mistake that can be made is to misjudge permanent hardship as temporary, and structural headwinds as cyclical shifts. The only antidote against making this mistake is a sound understanding of the business and its industry.
MCX fell 84% in 2013 when NSEL fiasco came to light. Muthoot Finance fell 63% in 2013 after gold prices fell 20% and RBI imposed 60% LTV requirement. Inox Leisure fell 36% in 2018 when a PIL was filed to allow outside food. Canfin Homes fell 65% in 2018 after Canara Bank failed to sell its 30% stake at its desired price and IL&FS default further affected sentiments towards non-bank lenders. These were temporary hardships where we remained invested and/or added further and have been rewarded well.
Dish TV fell 80% due to Jio aggression and OTT popularity. DB Corp too fell 80% despite high cash generation and growing in circulation due to threat from internet. These are permanent hardships and we had to exit at par in former and loss in latter.
So long as demand continues to remain robust, business debt free or has access to capital, raw material or end product prices are cyclical, and remedial measures remain in control of management, the hardships are temporary.
However if there is challenge to long term sustainability of demand, or new technology brings in better and/or cheaper solutions hardships are permanent.
Curiously temporary hardships have higher visibility, permanent hardships are less noisy. Management and media miss the latter or hope it to be temporary. Nonetheless, ability to distinguish between the two can be profitable. Wherever prices misjudge the hardship to be permanent, it can be a good buying opportunity.