The Golden Thumbrule: Is it time to exit? Aniruddha Sarkar’s playbook for spotting sector wear and tear

In the second part of “The Golden Thumbrule” series, Aniruddha Sarkar delves into the other side of the market cycle—the fall from grace. While identifying emerging sectors early is a known path to wealth creation, knowing when to step away from once-loved sectors is equally critical for preserving gains.

From paints to IT and FMCG, sectors that were once the toast of the markets are now navigating challenging terrain. Sarkar breaks down why this happens—be it valuation excesses, margin pressures, or structural fatigue—and how investors often miss early warning signs hidden beneath the surface.

He also addresses the age-old investor dilemma: When do you exit a sector that’s still popular but showing signs of wear and tear? With insights into valuation metrics like the PEG ratio and the role of earnings support, Sarkar lays out a simple but powerful framework for timing exits.

Above all, he reiterates a timeless investing principle: The best opportunities often lie in sectors no one is looking at—just before they turn into market favorites. Edited Excerpts –

Kshitij Anand: We have talked about sectors that have gone from zero to hero, but let us talk about sectors that have gone from hero to zero. Paint, IT, FMCG—you could say they were once the darlings of the capital markets, but now, not so much. So, what usually causes this fall from grace? Or is it just that the cycle has played out and now it’s time to book profits? What are your views on that?

Aniruddha Sarkar: See, I would say that obviously, each of these sectors you mentioned—and in fact, if you look at the companies within these sectors—they continue to be world-class companies, exceptionally well-managed, with top-quality management. Where they may not have performed well on the equity market side is that, as I always tell investors and my team, excesses happen on both sides—on the upside and on the downside.

Now, each of these sectors had its own issues. If I go back to the paint industry—before getting into the issues—what was happening is that, for five to ten years, these sectors saw a good upcycle, which I would say was structural. As a result, valuations went through the roof. When that happens, and then a couple of years of disappointment follow, that’s when multiples start contracting.

Each of these sectors had their own pain points. In the paint industry, for instance, there was never this level of competition before. Now, you have big players entering the space. The pie remains the same, and with two large players entering, margins and market share are bound to take a hit. Also, there is a lot of M&A activity happening in the paint industry, which adds to the disruption. So, we saw margin contraction, and top-line and bottom-line growth got impacted.

In the IT industry, there was a golden period during COVID. Everyone was working from home, companies were saving costs as employees weren't traveling overseas, and margins improved. On top of that, every business wanted to migrate to the cloud—and Indian companies were best placed to help. It was a golden period. But the market extrapolated that this golden period would continue forever—which doesn’t happen. Markets don’t work that way.

In the last couple of years, we’ve seen deal pipelines weakening, margins contracting, attrition going up, and uncertainty in the US and Europe—all of which have led to IT project delays. All this caused a multiple contraction from the highs of the COVID era.

In FMCG, demand from rural India, especially the agri side, remained weak for most of the last couple of years. Although demand has picked up in the past year, earlier it was very weak. Raw material prices had gone up, margins contracted, and most FMCG stocks trade at 40x, 50x, even 60x P/E. If a stock trades at 60x earnings and grows earnings at just 10%, accidents are bound to happen.

So, I would say these sectors all had their golden period, and now they’re going through a painful phase of multiple contraction.

Kshitij Anand: Let me also quickly ask a related question. Is underperformance always about expensive stocks correcting? Or are there hidden structural issues that we often miss until it’s too late?
Aniruddha Sarkar: I would agree with the second part. Typically, what happens—as I mentioned earlier—is that excesses happen on both sides. When things are going well, people are willing to pay any price for good news. And what happens is, good news gets amplified, while bad news gets swept under the carpet. It’s only when the bad news under the carpet becomes too large and starts causing pain that people lift the carpet and see what’s really underneath. That’s what leads to underperformance.

A good example is private banks. They had a golden period where they consistently outperformed PSU banks. This was during the NPA cycle, when PSU banks were the most hated segment, and private banks were the darlings of the Street. Private banks traded at 4x price-to-book; PSU banks traded at 0.4x. That was a massive difference.

But when the NPA cycle ended and PSUs started showing good numbers—ROEs, ROAs, everything improved—the question arose: if the operating metrics aren’t vastly different anymore, why should valuations be so different? So, PSU banks’ valuations moved up, and private banks saw valuation contraction—from 4x price-to-book to 1.7–2x.

Now, during this period, it’s not like private banks weren’t growing. They were still growing at 15–18%, had excellent management, solid teams, and great brands. But they still went through a painful period of multiple contraction. Why? Because the market constantly weighs opportunities.

If I’m an investor or a portfolio manager, I can’t invest in 100 or 200 companies. I have to weigh idea A against idea B. And when you see that one trades at 8x the valuation of the other, you start questioning if that difference is justified.

So, in one line—underperformance is a result of valuation contraction in expensive stocks, and a valuation upcycle in under-owned or undervalued ones.

Kshitij Anand: In fact, the next thing I wanted to ask—and I’m sure our viewers watching this show would also want to ask—is actually putting you in a bit of a spot. As a portfolio manager, how do you decide when to exit a sector, especially one that is still popular but showing signs of what we call wear and tear?
Aniruddha Sarkar: It’s a very difficult question you've asked me. And to be honest, I wish…

Kshitij Anand: I gave the disclaimer at the beginning.
Aniruddha Sarkar: No, absolutely. I would say it’s a very difficult question because, to be honest, you can’t always get your exits right. There have been many instances when, after seeing a sector hit its highs and then decline, you feel, "I should have exited back then." That’s a natural reaction—for both investors and portfolio managers like us.

But yes, over the years, I would say there are certain guiding rules that help reduce the mistakes I used to make 18–20 years ago. One simple rule I always follow—and tell investors as well—is this: are the earnings supporting the valuations?

That’s the most important factor, because ultimately, everything boils down to earnings growth. Valuations can move from a PE of 10 to 50, but if earnings don’t grow, that 50 PE will eventually return to 10. When that happens, a hot stock can suddenly become a hated stock. However, if earnings grow at 25%, 30%, or 40% CAGR during that period, it supports the multiple expansion.

So, the most important factor in deciding whether to exit or reduce exposure in a sector is tracking whether the earnings support the multiple. That brings me to a basic metric—the Price-to-Earnings Growth (PEG) ratio. If the PEG ratio exceeds 2, it's a sign of caution. There’s no magic number, but 2x is my internal benchmark. A PEG above 2 signals that the market may be pricing in more than what the company is actually delivering. Conversely, a PEG below 1 is attractive, meaning earnings are growing faster than the market is pricing in.

Another key sign to watch is if the price movement is outpacing earnings growth. A company may be doing well, but sometimes, there's too much capital chasing too few ideas. And thanks to WhatsApp groups these days, a new idea gets shared, and within 10 days, a stock can go from attractively priced to expensive. If price appreciation and multiple expansion happen faster than earnings growth, that’s another warning sign—it’s often better to book profits in such cases.

Aniruddha Sarkar: In fact, I mentioned this almost at the beginning of our discussion, and I’ll come back to it because it truly is the golden rule of investing—anywhere in the world.

If no one is looking at a sector—or it’s a hated sector—that’s the time to start looking at it. The moment it becomes the most recommended sector by everyone in the market, that’s the time to be cautious and consider reducing your exposure.

There are plenty of examples. As I mentioned earlier, 24–36 months ago, when I was bullish on PSUs and defence, I used to spend hours explaining why those sectors deserved attention. Just six months ago, the same people were telling me why defence is a good sector. Now, obviously, defence stocks have surged because of geopolitical developments like the Indo-Pak tensions and increased defence manufacturing. But that just proves the point.

So, the golden rule is: start looking at sectors and companies when no one else is. That’s when valuations are comfortable. And when everyone is talking about a sector—when it’s the hot theme of the day—that’s the time to get a bit cautious and start taking some chips off the table.

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)