Monday, 27 January 2014

Selling at a loss hurts...but lazy capital hurts more

Towards the end of last year I wrote quite a long post on the need to constantly re-evaluate your portfolio.  The chances are that you do not understand why you are holding onto every one of your stocks.  Worse, there may be some stocks in your portfolio which you know are never going to recover but which you hold onto because the original thesis (which was great) never panned out and you now have lazy capital.

Just because a share has decreased in value does not mean it is a bad investments

An investment thesis almost never plays out straight away.  If you buy a share or other investment and it goes down over the next few weeks or months don't stress about this - if your thesis still holds and you have confidence in it, then have the courage to stick by it.

An investment thesis can sometimes take years to play out but the rewards are there at the end - one stock I owned kept falling for almost 2 years but I still believed in my thesis and then within the space of a few months it more than doubled in value from my original buy in price on the back of that thesis.

Where your thesis has not played out...and you have turned out to be wrong then it is better to admit your mistake quickly

The first step is to stay on top of your investments.  If you have invested in a stock that seems undervalued and then the market fundamentals of that stock deteriorate rapidly then it is better to admit your mistake quickly.  Several years ago I invested in Fairfax Media (ASX: FXJ) on the basis that the stock was trading on an extremely cheap multiple - implying that the market expected print media to go out of business rapidly (i.e. a significant earnings deterioration in a very short period of time).

I thought that the market was over-doing it and I invested in the stock at $0.99 per share on the basis that I thought that it was worth at least $1.20.  In hindsight the market was completely right and I was completely wrong.  The stock very rapidly declined in value, with earnings being eaten away much more quickly that I expected and before long the stock was trading in the mid $0.30 range.

The dilemma I then had was that the stock once again appeared to be
good value at this price.  I considered doubling up but I had seen the dangers of investing in a stock in an declining industry when you cannot predict the pace of decline.  It turned out that this time I was right and the stock recovered to the $0.60 mark.  A few days ago I sold out of FXJ at 0.685 making a loss of 31% before transaction costs.

The stock did not move for a very long time...and I lost the ability to use that capital to invest in other opportunities

While it was a good idea not to sell the stock when it was at $0.30, for a long period of time the stock hovered around the $0.60 mark before I decided to sell it.  The market advanced rapidly in the last year and while I held onto this stock waiting for another 10% recovery so I didn't feel so bad about the loss, the market went up significantly more than this in this time.

Waiting for an under-performing stock to recover without a clear investment thesis means that you lose the ability to invest in opportunities which you do believe in.  This is why it is so critical to constantly re-evaluate your portfolio.  There are several other stocks in my portfolio which are tying up my capital - some have big losses attached to them and others have big gains with one or two have just remained flat for a fair while.

This re-evaluation is a constant process and it takes time.  I recommend that anyone investing directly in shares engages in this process.  If it is too much work - I recommend doing something simpler like investing in index funds where you do not need to worry about this aspect of investing at all.

You May Also Be Interested In
Value investing: the trap of investing in declining industries
Reasons and tips to stay on top of your existing investments
Index funds: a cheap and easy way to access the share market
When to buck the trend and ignore the share market

1 comment:

  1. I've had a couple of specky minig stocks that have taken a bath. They are worth so little that I have simply put then in the bottom drawer as its not worth paying the transaction costs.

    Completely agree with the use of index funds and ETFs, I use them for all of my investments. Gives me a wide spread of investments across markets so I don't need to stress about individual stock performance.

    Can you do a post on how you're tracking to your $90m target? Are tracking your progress to your target on a granular level, beyond just your P&L/expenditure tracker?