The Motley Fool

Will Under-Performing Investments Ever See the Light of Day?

This is probably a feeling every investor has experienced at some point during his investment journey: Will your under-performing investments ever turn around and see the light of day? Or will they simply continue to languish in obscurity, their share prices spiraling down into oblivion?

Most investors have some duds in their portfolios that are performing poorly. When I asked a few of my friends, most of them came clean on a few positions in their portfolios that are doing poorly, or had declined significantly in price since they purchased them. The question here is, what should be done about such stocks? Should we wait for the businesses to recover, or should we simply sell them off and shift the money to a more promising idea?

Let’s review a few scenarios to illustrate the best course of action.

Business decline — structural

If the decline in revenue and profit was a result of a structural change within the business, investors may wish to seriously consider divesting the position. A structural change may come about due to a variety of reasons: new entrants flooding the market with cheap products (i.e., starting a price war), the introduction of substitute products, or customers switching to cheaper suppliers.

Investors need to assess the reasons for the decline on a case-by-case basis and determine if the disruption is temporary or permanent. If a structural change alters the business prospects and renders the company unable to compete effectively, this would affect the investor’s investment thesis, and he should consider selling.

Business decline — temporary

If the decline is established to be a temporary phenomenon, then the savvy investor should take the opportunity to accumulate more shares in order to average down on the position. If you have confidence that the investment will eventually perform well, you should muster up your courage and aggressively add to your existing holdings.

Business decline — cyclical

A third scenario could arise when the business decline is due to a cyclical downturn the company is experiencing. Investors need to tread carefully, here, since they may not know how long the cycle lasts, or if there are any changes to the nature of the cycle. You should hold your investment if there is evidence that the cycle will eventually turn up and benefit the company in question. If the cycle drags on for years at its low point without any discernible improvement, then you may wish to consider re-deploying your funds elsewhere.

The Foolish bottom line

Some say it’s darkest just before the dawn. It can makes sense to hold on — or even buy more shares — if you can see light at the end of the tunnel for a languishing investment. However, there are also cases where it’s darkest just before it turns pitch-black! Investors should be wary of such situations as it means your investment might turn sour, and it would be a better idea to re-allocate your capital to a more promising investment idea.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.