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What To Do When Your Stock Loses Money

question how wonder Recently, there has been a flurry of response over at our Foolish Facebook page with investing questions. One of them which caught my attention as it is often faced by many retail investors.

The question is (question’s lightly edited):

I have in my portfolio stocks which I had bought when the prices were high but worth very little now, should I keep them or sell them and reinvest in other stocks?

I’m sure most of us have encountered this question at some point in our investing journey. Before going into the hard facts of what steps should be taken, let’s experience the emotions one would feel when faced with this kind of situation…

A Dilemma

Your stock is losing money. You want to sell, but deep in your heart, you think: “The paper loss is not realised until I sell it, maybe it will bounce back and I will sell when that happens!”

On the other hand, you see your stocks languishing in despair while other stocks are constantly on the rise. You are also thinking if you should offload your holdings, and utilise your capital in a more profitable security.

In a perfect world, everyone aims to profit from buying low and selling high. Unfortunately, the reality has proven that buying low can still get much lower, especially when the company is not doing well.

A classic example is Creative Technologies (SGX: C76) on how it has fallen from its grace due to a lack of innovation and continued price wars with Apple. At the height of its glory in 2000, its stock price was at a high of S$59.50 but has since fallen to an all-time low of S$2.31 at the time of writing.

What You should do

In order to stay calm and think straight in the face of the price decline, ask yourself the following questions:

  1. Why did you buy the stock?
  2. What happened?
  3. Does that change affect your reasons for investing in the company?

This approach requires you to reflect back on your investing style and what went through your mind when you first bought the stock. The first question will be an easy one. Did you buy a company because of its strong fundamentals? Did you do your homework beforehand to understand the company or did you purchase it because a certain report said it will soar?

After knowing the reason of buying the stock, you have to grapple with the decline in stock price now. If a stock has gone down in price, there is usually a reason for it. Determine whether the drop in share prices is due to temporary bad news or permanent poor business operations.

There is one Warren Buffett quote that goes: “The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table”.

One example I can think of is Osim International (SGX: O23). It suffered a loss due to a bad investment in the U.S.-listed Brookstone holdings and its share price hit an all-time low of S$0.055. After it resolved its problems, the company’s share price surged to S$1.95 at the time of writing, a 34.45x increase.

Lastly, let’s proceed to the third question: is the change material enough that you would not consider the company again if you were to invest your money? Try combining the answers you have for questions 1 and 2.

If you have bought into a stock due to hearsay on the street that it will soar but you see that the underlying company fundamentals aren’t really improving, it is better for you to offload the position in the company and reinvest the money somewhere. In Peter Lynch’s book One Up on Wall Street, he mentioned about the silly things people say about stock prices and one of the quotes go like this, “If it’s gone down this much already, it can’t go much lower”.

On the other hand, if you re-evaluate your investment considerations and find that the firm is still fundamentally strong, load it up like what Warren Buffett will do when there is bloodshed in the markets. During the 2009 financial crisis, although Lehman Brothers and Bear Stearns show even the big banks can go bankrupt, our local banks like DBS Group (SGX: D05) and United Overseas Bank Ltd (SGX: U11) have strong balance sheets. Investing in their depressed prices during that time would have easily helped you score more than 100% gain as of today.

Focus on your Selling strategy

Many investors only focus on the reasons why they would invest in a company. They focus on the upside and tell themselves that “I will earn big bucks on this stock” but ignore the downside that it may bring. The ugly truth is that no stock investment is fool-proof and stock market fluctuations can drag down your stock prices beyond your wildest dreams.

Thus, it is vital to constantly review your purchase decisions when something goes wrong. If you have made a mistake, bite the bullet and learn from it wisely. Opportunities are aplenty for you to start over again. Lastly, remember not to get emotionally attached to companies, and making smart sell positions will become easier and easier.

For the reader who sent in this question, I hope this article can be of benefit to you.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.   Motley Fool Singapore contributor James Yeo doesn’t own shares in any companies mentioned.