When Averaging Down Makes No Sense

Let’s imagine something here. You had gone back in time to the start of January 2007 and for whatever reason, you had decided to buy shares in Cosco Corporation (Singapore) Limited (SGX: F83), Ezra Holdings Limited (SGX: 5DN), and Swiber Holdings Limited (SGX: BGK) that day.

You held onto those shares and two years later, at the end of December 2008, you found them to be trading at prices at least 40% lower than your purchase level. Seeing that they’ve suffered from steep declines, you then decide to average down.

Share price chart for Cosco, Ezra, and Swiber from 1 January 2007 to 31 December 2008
Source: S&P Global Market Intelligence

Sadly, averaging down would have been a poor move. From 31 December 2008 to 11 February 2016, the trio have seen their shares lose a further 67% or more.

Share price chart for Cosco, Ezra, and Swiber from 31 December 2008 to 11 February 2016
Source: S&P Global Market Intelligence

At this point, you might be thinking, “Why am I randomly bringing these three shares up?” Yesterday, my colleague Chin Hui Leong had published a great article. In it, he wrote that “averaging down can turn out to be a horrible idea if the underlying business of the stock in question deteriorates further, causing the price to drop even harder.”

The point of bringing up Cosco, Ezra, and Swiber is to use them as examples of what Hui Leong had cautioned about. The trio of companies had seen their businesses crumble from 31 December 2008 to today. The table below, showing the steep drop in their earnings over the years, makes it clear:

Cosco, Ezra, and Swiber's earnings table
Source: S&P Global Market Intelligence

It’s worth noting that the experience of Cosco, Ezra, and Swiber are not unique. In fact, of all the Singapore-listed companies that I have data of today, there are 131 companies that have seen their shares fall by at least 30% from the start of 2007 to the end of 2008, and then by a further 30% or more from 31 December 2008 to 11 February 2016.

What’s interesting is that nearly two-thirds of the 131 companies have lower earnings today as compared to end-2008. As Hui Leong suggested, averaging down on a stock can be a bad idea over the long-term if its underlying business performances in the future would worsen.

This is important now. The Straits Times Index (SGX: ^STI) is currently down by around 30% over the past year, suggesting that many stocks have fallen as well. With falling stocks come the possible temptation to average down. But before you do so, take a good hard look at the stocks’ businesses. It is worth keeping in mind how blindly averaging down on stocks with crumbling businesses can possibly result in eventual pain to your portfolio.

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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 doesn't own shares in any companies mentioned.