Year Of The Horse – Why The Long Face?

The Motley FoolGong Xi Fa Cai!

As the serpent slithers back into the undergrowth of time, we wave a fond farewell to the Year of the Snake and welcome in the Year of the Horse. Yes, it is out with the old and in with the new.

Out with the old and in with the new” might be the right mantra for Chinese New Year. However, it might not always be the right thing to do with our investments.

In fact, it can sometimes be a case of the older an investment gets, the better it becomes.

Any long-term investor in Keppel Corporation (SGX: BN4), Sembcorp Marine (SGX: S51), Jardine Cycle & Carriage (SGX: C07) and Genting Singapore (SGX: G13) will probably be the first to attest to how well those shares have performed. Each of those companies has delivered total annual returns in excess of 20% since the Millennium.

Worth less or worthless?

However, what to do with old and poorly-performing investments can be a prickly topic for many investors.

When we invest, it is not unusual for an asset to be worth less than the price we paid for it. That doesn’t necessarily make it worthless. It just means that it is not worth quite as much as when we first bought it.

But once we learn how to handle underperforming assets, we can begin to understand how it can also improve our long-term returns.

Those of you who have been subscribers to Take Stock Singapore since the outset should be familiar with the exploits of hapless Bob.

This is the Bob who complains about the contents of his lunch-box every day but confessed to his colleagues that he personally packs his own lunchtime meals.

This is the same Bob who could not understand why he was unable to sell his red-hot penny stock when he wanted. That is until his broker told him that the reason the stock was rising was because he was the only speculator buying it.

Today, I have another story about Bob.

Penny dreadful

One day Bob’s work colleagues invited him to join them for lunch at a newly-opened restaurant. He lamented that he couldn’t because he had to spend his lunch break reading a book that was recommended by a friend.

He said it was a badly written book and a truly awful read. But since he had already paid an arm and a leg for the book, he felt obliged to finish reading it, even though he knew it would be a dreadful waste of time.

I wonder how many of us can relate to that. How many of us have sat through a terrible movie simply because we felt we had to because we had already paid good money for the ticket?

Welcome to the world of sunk cost, otherwise known as when to stop throwing good money after bad.

Should I stay or should I go?

The concept of sunk cost is particularly relevant today, when stock markets have been rattled by a sell-off in emerging markets.

Although Singapore is not an emerging market, it has still been affected by events happening elsewhere. So, when we look at our portfolios, it is possible that some of our investments might not be worth as much as when we bought them.

Should we keep them? Should we sell them? Or should we buy more?

The answer is quite simply that it depends. There are times when it makes financial sense to increase our holdings. On other occasions it might be better to cut our losses.

What is important is not the price that we paid for the asset. Instead it is whether the market has mispriced the asset subsequently. Every asset has an intrinsic value. This is its underlying value, which is generated by its future earnings.

Ships Ahoy

If the market value of the asset is less than its intrinsic value, then buying more would, in the words of Warren Buffett, be profiting from the market’s folly.

But if you are hanging on because you cannot bear to crystalise a loss, then, again, in the words of Warren Buffett, you would be patching leaks on a chronically leaking boat.

According to a recent report, almost US$940 billion has been erased from the value of emerging market equities since the US Federal Reserve signalled in May that it would start scaling back bond purchases.

There are two ways of looking at that.

One the one hand there could be lots of leaking boats having trouble staying afloat in the absence of cheap money. On the other hand, there could be lots of undervalued boats just waiting for us to profit from the market’s folly.

Knowing the difference between the two could improve your long-term returns.

A version of this article first appeared in Take Stock Singapore.

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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 Director David Kuo doesn’t own shares in any companies mentioned.