The difference between a damaged company and a damaged stock can be tricky and subtle. But it is also true that the markets are the best advance warning system for damaged companies. That is where the biggest opportunity arises. You must go in and buy damaged stocks where the company’s core strength is intact. Also, sell damaged companies where stock damage has just begun.

The difference is subtle but very significant. My personal experience with 2 investors will serve to underscore the subtle difference between damaged stocks and damaged companies. The first case was of an investor who had substantial holdings in Infosys in early 2003. After the 30% correction on results day, he just sold off his entire stock of Infosys. Between 2003 and 2014, Infosys became a multi-bagger.

Another case of the exact reverse situation was with another company, Educomp in 2007. The investor continued to hold on to the stock, despite indications of squeezed margins and unmanageable debt in the books. By 2012, the stock price was a fraction of its peak price and does not look like bouncing back even in the distant future. These 2 cases highlight the difference between damaged stocks and damaged companies.

Infosys’ financials and fundamentals were never in doubt. It was always a zero debt company and had top quality management and execution skills. Educomp, on the other hand, was overstretched and had a fragile business model. The question now is how do you differentiate between damaged stocks and damaged companies?