In 2014 EPS (Earning Per Share) of CVS pharmacy, a US-listed pharmaceutical company, fell by approximately 10% to $0.95 from $1.04. One of the significant contributors to this fall was the bold decision by the company to stop selling tobacco products in February 2014. Analysts estimated that by this decision, the company would lose revenue to the tune of $2 billion. Around $1.5 billion would be directly from tobacco products, and the other 0.5 billion would be an ancillary revenue loss from consumers who buy these tobacco products. As Simon Sinek mentions in his book “The Infinite Game”, the company took this decision to be true to its mission statement. There was no public outcry, scandal or media pressure. In short, the decision was a result of no external factors. Accordingly, the stock price reacted negatively but only to regain and ultimately make a new high.
While the stock price reaction may seem logical, this logical thinking is the lazy way of reacting to a situation. The next quarter after the implementation, the EPS went back to $1.06 and averaged $1.77 for the next three years, clocking a growth of 70%. Another logic-defying thing that happened was the actual sale of cigarette packets. CVS was selling 700 packs per month per store. Logically it meant that the sales would now shift to other stores making shares of those companies a better growth prospect. As mentioned in the book, the sales did not go anywhere else; they just went nowhere. All states where CVS had more than 15% market share experienced an overall cigarette sales decline of 1% across all retailers.
The point I am trying to make is that executing a decision of Buying/ Selling / Holding stock cannot be based on just a logical story that the media may be telling us. I have seen umpteen cases where people have bought a stock just because a renowned investor has purchased a stake in that company. Other people react based on a regulatory announcement and several other things. Logical thinking is a valuable tool for making decisions, but more is needed when it comes to direct equity investing. This is because many factors can influence a company’s stock price, and not all of them can be predicted or understood through logical analysis alone.
Take, for example, the covid era, when the businesses were shut, but we experienced a spectacular bull run from March to October 22. Similarly, we have seen a massive explosion of subscriber growth in the telecommunication sector, but the stock returns are far from the same.
These examples illustrate that while logical thinking can be a valuable tool for understanding a company’s fundamentals and making investment decisions, more is needed to fully understand the complex and dynamic factors influencing a company’s stock price.
In conclusion, Direct equity investing requires a thorough and holistic approach. It requires understanding the company’s fundamentals, analysing the industry dynamics, keeping an eye on the macroeconomic factors, and being aware of the non-fundamental factors that can impact the stock price. Logical thinking can be a valuable tool in this process, but more is needed. It’s essential to consider all the factors and take a comprehensive approach when making investment decisions.