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When Your Stocks Crash, Here’s The 1 Key Question You Should Ask Before Doing Anything

If you find that your stocks are down since 2015, don’t be surprised.

Singapore’s market barometer, the Strait Times Index  (SGX: ^STI), has fallen by 25% from its peak in 2015 (reached in April) to yesterday’s close.

Furthermore, only seven of the 30 stocks that make up the Straits Times Index had produced a positive return in 2015. The three worst stocks came from the likes of Noble Group Limited (SGX: N21)SembCorp Marine Ltd (SGX: S51), and SembCorp Industries Limited (SGX: U96).

In such a situation, your stocks may have fallen hard. You may be thinking of doubling down on those stocks. But before doing anything, we have to get into the right mindset. To do that, there is one key question to ask of ourselves for our stocks in the red: “What if you only found out about your stock today?”

The question above may be critical for our mindset, especially when it comes to doubling down on a stock that has made a loss for us.

Asking the question helps in detaching ourselves from the anchoring bias. It forces us to ask if we would invest in the same company if we just found out about it today. If you can adopt this question, it can give you “fresh eyes” to look at a company.

Let’s take Super Group Ltd (SGX: S10) for instance.

Shares of the instant coffee maker sank by more than 26% in 2015. If you had bought Super Group shares at the start of 2015, you may be dismayed with its performance. Or, you may be tempted to double down on the stock to lower your cost basis.

But, the better thing to do is to ask yourself where Super Group – as a business – stands today, as if you did not own it.

Super Group’s revenue has declined by 5% year-on-year for the first nine months of 2015. Lower sales has led to the company’s profit falling by a hefty 26% over the same period. The chart just below shows how Super Group’s balance sheet (more specifically, the level of its cash, borrowings, and net cash position) has changed since the fourth-quarter of 2013:

super group cash
Source: Super Group’s earnings report

The next chart you see illustrates Super Group’s quarterly free cash flow (FCF) for the same period:

super group fcf ofc
Source: Super Group’s earnings report

Super Group had generated $23.6 million in FCF in the first nine months of 2015; this is a substantial improvement from the $1.1 million in FCF that was seen in the corresponding period in 2014. Meanwhile, the company’s net-cash position is at $71 million as of 30 September 2015; this is again an improvement over the net cash position of $47 million a year ago.

These are positive signs for Super Group. The bugbear, though, is whether Super Group is able to reinvigorate top-line growth which has disappeared in 2014 and the first nine months of 2015.

With the facts laid out clearly on the table, the Super Group shareholder should be able to make a better decision on what to do with the company’s shares on the basis of where he or she sees the business heading toward in the years ahead.

To be sure, we may not always be right on our investment decisions even if it were made in the manner above.  But I submit that investing on the basis of the underlying business (like what I have tried to show with Super Group) will far outpace any decisions that are based solely on how much our stock prices have fallen.

Foolish takeaway

Before we double down on our stocks, we have to get into the right mindset first.

When faced with share price drops, it is important to distinguish between temporary losses and permanent losses. Permanent losses occur when there is permanent damage to the underlying value of a business.

A market decline – like what we have now – could be the best moment for reading up on the business performance of the stocks we’re interested in or already own. By doing so, we may catch sight of stocks that have had poor stock market performance but great business performance. In turn, it may lead us to stocks that outperform over the long term.

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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 Chin Hui Leong owns shares in Super Group