Should You Buy More Of A Losing Stock?

The Motley FoolEvery week I pop into the BBC Studios in Beach Road for a one-hour live show on the World Service called Business Matters.

To be on the safe side, I always leave my flat shortly after seven in the morning to give myself plenty of time to settle into the studio. Failing to do so could trigger a panic-attack in the production team at London’s New Broadcasting House.

On most occasions, the trip to the studio goes swimmingly. But last week, something awful happened – the taxi I was riding in suffered a puncture. I had to make a snap decision. Do I wait for the driver to change his car tyre or do I jump ship and catch another cab?

Why, you might ask, am I sharing my private hell with you?

The point is this: The time that I leave my apartment is not going to cut much ice with my London producers. All they want to know is whether I am sat in front of the microphone by the time the show goes live.

In other words, the time that I leave my flat is, to put it bluntly, immaterial.

Something similar happens when we buy shares. The moment that we buy a share, the price that we pay for our investment becomes irrelevant. It is a sunk cost..

Recently, someone asked me if I have ever lost money buying shares. Hmmm… I thought to myself. What an intriguing question and one that is not easy to answer.

That is not to say that I am trying to be deliberately evasive. But if you think about it for a moment, that one simple question can be answered on a number of different levels.

Do we, for example, define a winner as a share that goes up in price shortly after we buy it? And if we use that uber simplistic definition of a “winner”, then what exactly does “shortly after” really mean?

Would an hour be an appropriate definition of “shortly after”? Or should it be a day, a week, a month or even a year. Another consideration is whether dividends should be included in deciding whether we have a “winner”. Are we concerned only with capital appreciation or should total returns be used?

Defining a winner by using short-term price gains might be useful for traders who enjoy flipping stocks regularly. But it is less appropriate for those of us who buy shares with the intention of holding them for the long haul.

We need to remember that share prices can often be a reflection market sentiment. The prevailing feelings in the market can, and often does, affect the value of companies.

But – and this is the crucial point – they are not necessarily a good reflection of the intrinsic value of the business.

Share prices, if you haven’t already noticed, have a terrible habit of bobbing up and down, depending on which way market sentiment decides to blow. But a winning share and a winning company are two very different beasts.

One simple technique that we can all learn as we become better investor is to try and forget the price that we paid for a share. That forces us to evaluate a share on its current merits and its future prospects.

If a share that you already own looks cheap compared to its intrinsic value, then buying more could make sense. The price that you originally paid for the share is irrelevant as to whether you should buy more.

If you buy more at a cheaper price than your original purchase cost, then you have effectively averaged down. If you buy more at a higher price, then you have averaged up.

Averaging-down and averaging-up should always be a consequence of your investing decision and not a reason for making the investing decision.

As Benjamin Graham once said: “You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.”

If you bear that in mind when you invest, you should be less likely to puncture your portfolio, unlike my cab driver who, unfortunately, did.

This article first appeared in a SIAS newsletter.

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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.