Big crashes in broader markets aren’t as common as big and sudden fall in share prices of individual companies. If you have been investing in stocks for quite some time, then every now and then you would have come across significant fall in the prices of individual stocks. A price fall of up to 2-3% may not have a big trigger behind it. But if a stock is falling 20%, 30% or 50% in a short span, then there is always an inducement behind it.

By identifying why stock recommendations have undergone significant price erosion, an investor can be better equipped to decide whether it is time to sell that stock position or whether it is an opportunity to accumulate more at lower prices.

Of course many times, the reason may not be obvious up front.

But significant collapse in shares of individual companies are generally due to few big reasons.

Here we discuss few important ones:

1. Sale of Shares by Major Stakeholders

Most companies have few big shareholders (like promoters, financial institutions, mutual funds, insurance companies, other big investors, etc.) holding a majority stake in the company. Generally, it is believed that these entities have sufficient information about the business to have a reliable view of the stock and hence, hold big positions.

So for some reason, if any of these investors sell their shares and reduce their stake significantly and/or suddenly, it is taken as a negative sign by the Indian stock market. And since the sale generally leads to the introduction of a large supply of shares in the market, it goes on to reduce the share price due to lack of sufficient demand for available shares.

Example: Very recently, PC Jewelers – a well-known Indian jeweller saw its stock price tank suddenly when it became evident that the founders had gifted shares to family members who in turn were selling them in the open markets. The issue is still too recent to make a clear judgement, but it has nevertheless raised corporate governance concerns directly or indirectly when the shares held by the major stakeholders are being sold in open markets.

2. Not Meeting Estimates by Big Margins

For widely tracked companies, generally, there are consensus estimates about what the next periodic earnings would be.

But when the company’s declared earnings are way off the mark from what the broader Indian stock market expected, then the stock can go down very swiftly. This is because such big divergences are due to critical reasons which may have long-term implications for the companies. This, in turn, makes investors jittery about the future prospects and in panic, sell such stocks.

At times, Indian share market can pull down stocks wrongly due to faulty analysis of the results. This happens when market participants fail to determine the real reasons for the company missing out on meeting earnings estimates. It’s possible that the reason might be a one-time temporary issue which may not have any long-term implication for the company’s well-being. In such cases, the crash in share prices is mostly a knee-jerk and unnecessary reaction.

Example: This too happened very recently. India’s largest budget carrier Indigo’s (InterGlobe Aviation) shares plunged by more than 10% in a day (and have continued to fall more since then). This happened after the company reported a huge drop (~73%) in its fourth-quarter profits due to a number of factors such as higher fuel costs and forex loss. The huge drop came as a big surprise as the Indian stock market was expecting the company to deliver a performance in line with its previous consistent track record. The sudden exit of company’s head also added to the negativity around the stock.

3. Popular Research House (or Analyst) Downgrades

At times, if a company receives a negative report and is downgraded by a well-followed research house / stock advisor / analyst, it can push the stock price of the cliff.

Why does it happen? Because such negative triggers can impact the short-term perception of the market participants.

Most of these participants are focused on short-term price moves and consider these downgrades as a sign of weakness. The result is that in absence of fresh positive triggers, they may dump their positions. As and when this happens, it increases the supply of stock in the market which cannot be absorbed immediately. This can send the stock price plummeting.

4. Change in Future Guidance

When companies declare results, many of them also release their forecasts or provide guidance about the future prospects for the company.

If the guidance or forecast paints a bleak future (which managements desperately try to hide), then this can trigger investors and traders to dump their stocks. Such continuous selling can lead to big price erosion.

At times, this can happen at a sector level as well. For example, if the government decides to impose some additional duty/restrictions on all companies of a sector, it can create sector-wide panic and push down share prices of all the companies in the sector.

Example: Infosys had long been a bellwether of the Indian IT sector. But since 2016 and due to the headwinds faced by the sector, Infosys management began to regularly come out with not-so-great guidance figures. This in turn kept resetting the expectations from the stock downwards. The result has been that the stock kept grinding down to lower levels for some time (The prices have recovered since then to some extent.)

5. Unearthing of Frauds

Though most companies try to portray themselves to be epitome of transparency, the fact is that some of them are hiding skeletons in the cupboard.

And when these come out in public (due to any reason), then markets are not forgiving to such short term/long term investment stocks. The stock can crash heavily. There have been instances of stocks going down by more than 50% in a just a day!

Example: Public sector lender PNB recently faced a multi-billion dollar fraud from its exposure to well-known names of the precious stones sector. The stock fell by more than 40% in a matter of days.

What Should Investors Do?

If there is a big fall in share price of a company you hold/track, then such price move should not be ignored. Long-term investment investors need to look past the noise and try to understand the real issue.

Conduct fundamental analysis of stocks and check whether they have deteriorated from what they were before the event? If the answer is yes, then it means that it’s possible that the company will be unable to generate earnings and operate in the same manner as it has been doing and was expected to. So this can be ‘one’ reason to exit. On the other hand, if the fundamentals of such long term investment are still intact, the sudden fall in prices may represent an opportunity to buy more of the stock at a discount!

It is also important to examine the decline of stock price in relation to the industry. If the entire industry is going down, then the decision-making criteria would be different from what it would be when only one company’s share is going down in the industry.

To be fair, a small price correction is normal and healthy. But for all large price cuts, there is almost always a tangible reason behind the fall. A smart investor will examine the situation rationally and if the fundamental analysis of stocks state that the company have changed for the worse, then he would better equip himself to determine whether the time has come to sell the share or not from his stock portfolio.