Dear reader, I have an interesting investing conundrum that I might need your help with.
I had first bought shares of instant beverage manufacturer Super Group (SGX: S10) at a split-adjusted price of S$1.90 last June. Today, its shares are currently sitting at S$1.50, representing a 21% loss. In the same time frame, the Straits Times Index (SGX: ^STI) had moved up by 4.7% to 3,264 points, adding salt to my wounds with Super.
Super had been plagued with troubles recently after one of its key markets for its instant beverage products, Thailand, had experienced political turmoil. That partly resulted in the company’s 6% and 19% year-on-year drops in revenue and profit, respectively, in its latest first quarter results.
Meanwhile, I also own shares of Raffles Medical Group (SGX: R01) that I had purchased last August at S$2.90. At its current price of S$3.90, I’m sitting on a handsome 34.5% gain with the Straits Times Index having increased by ‘just’ 8.7%.
The healthcare provider had seen a healthy 8% growth rate in both its top- and bottom-line in its latest first quarter earnings. In addition, Raffles Medical also has some intriguing growth opportunities that are related to the development of a new medical centre and an expansion of its flagship Raffles Hospital along North Bridge Road in Singapore.
So, my conundrum is this: If I were somehow forced to sell one company, which should I choose? That’s where I might need your help. But before you give me an answer, if theories from behavioural finance are used as a guide, I would think that Raffles Medical Group might be the candidate being put up for sale by the majority.
Under behavioural finance, there’s an interesting phenomenon called loss aversion. An experiment described by my American colleague Morgan Housel would give a nice picture of what it’s all about:
“In 2005, a team of researchers from Stanford, Carnegie Mellon, and the University of Iowa gave a group of participants $20 each. They were then made an offer: You can flip a coin up to 20 times. If you lose the coin toss, you owe $1. If you win, you get $2.50.
Everyone in this situation should make as many tosses as possible, since there’s a 50/50 chance of accurately guessing a coin toss, and the reward for winning is far larger than the penalty of losing.
But the researchers found only one group of participants willing to make large numbers of tosses: Those with a lesion in the area of their brains that controls emotion.
Participants with normal brains threw in the towel after flipping a few losses in a row. People don’t like losing money, and even if you know the odds are in your favor, a couple losses will turn you off.
But those whose brains suppressed emotions kept on betting, regardless of past losses. Not surprising, given the odds and payoffs of the coin-toss game, they ended up with more money.”
Simply put, loss aversion is a mental flaw which most people with normal brains suffer from; for a gain and a loss of equal magnitude, the mental anguish we feel for the latter is a lot higher than the former. And importantly, this causes us to make poor decisions with our investments due to the disposition effect.
In investing circles, the disposition effect is a phenomenon whereby investors tend to hold on to losing investments and sell winning ones. Finance researcher Terrance Odean once did a study on 10,000 accounts at US brokerages for the period 1987-1993 and realised that individual investors are 50% more likely to sell their winners than their losers.
Although there are a number of factors that cause this disposition effect to take place, the idea of loss aversion is important here as well; when losses feel more painful than gains, it’s harder to change those ‘paper losses’ into real losses. That is why I think most of you would pick Raffles Medical to be sold instead of Super.
But, why exactly is the disposition effect harmful? Here’s an explanation by another US colleague of mine, Matt Koppenheffer:
“[N]o matter how you look at [share] returns, a surprising number of [shares] end up returning far more and far less than the average. Practically, this means that the practice of “locking in gains” and hanging on to losers is a good way to miss out on the market’s huge outperformers, stay stuck with poor performers, and earn lacklustre overall returns.”
This is not to say that investors should base their investing decisions solely on price movements; ultimately, it’s a company’s business performance that determines its long-term share price returns and thus it would be the business fundamentals of a share that should be the ultimate driver for an investor’s decisions. Rather, it’s meant to point out the harmfulness of constantly selling winners while holding on to losers, a mistake that many individual investors are prone to commit.
As for what I really intend to do with those two shares of mine, let’s just say that I have no need at all to sell any of my investments any time soon and that anypossible sale would have to be predicated upon a complete collapse of their long-term business fundamentals.
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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 writer Chong Ser Jing owns shares of Super Group and Raffles Medical Group.