A situation that many investors find themselves in is they purchase shares in a company, and then see the market value of the shares plummet. During hard economic times they may also see the company lose money, operate poorly, or their financial condition deteriorate. They hope that the company will get better, profit, and along with it the market value increase.
The truth is that some companies never return to profitability. And those that do turn a profit may likely remain mediocre or even below average. They may never return to a point where profitability and growth become above average, which is often required to increase the market value to a price where you can sell the shares at a gain or even break even (depending on the initial purchase price). The best example is during the tech boom and subsequent bust. Many investors purchased stocks at high prices compared to the companies intrinsic values, and were unable to sell the stocks at profitable prices, even years later.
Nortel – Many investors poured money into Nortel shares as the tech bubble grew, and they saw the stock price rise well over $100 in a relatively short period of time. Then came the crash, and almost all network and communications companies were hit hard. After nearly 10 years, the company failed to return to profitability. They became industry laggards even after several attempts to turn around, and finally filed for bankruptcy protection. The company’s assets are currently being sold off.
The decision many investors face from time to time in this type of situation is that if you sell, you lose money. But you hope that if you hold, there is a chance to gain something back. Many investors don’t give such a significant decision much thought or analysis. But investors need to look at the details of the company in question and its business outlook. They also need to conservatively calculate the probable return on investment and then compare it to what they would invest the recoverable money in, after selling the investment at a loss:
Here are a few factors to consider prior to making the decision:
– What is the current condition of the company? (financial, market position, etc).
– Is the current investment a bad one, or just experiencing a temporary market price decline that is not related to its business performance?
– If unprofitable, how likely are they to return to profitability?
– Does management have a plan, the correct culture, policies, in place?
– Is top management leaders that can inspire a turn around effort?
– What caused their stock price to decline in the first place?
– Was the purchase price much higher than the intrinsic value to begin with?
– Is the stock or company one you wish to hold long term?
– How did the holding fit in the investment plan/strategy? Does it still fit?
– What is the likely return from holding it?
– What is the return from selling the investment at a loss?
– What would the money be invested in, and what return would that new investment likely to yield?
– How does the two returns compare?
– How does the new investment fit into the long-term plan?
After detailed analysis, the decision becomes much simpler and there are quantitative numbers as well as other comparable factors. Although some investors may find it difficult to sell investments at a loss, it is sometimes a good decision which leads to overall investor profitability. Investors are people and sometimes there is a tendency to have an attachment to a particular investment(s).
Warren Buffett learned this valuable lesson when he was very young, from an experience he had at the racetrack. He successfully incorporated the lesson into investing. In the book, The Snowball by Alice Schroeder, the racetrack experience is detailed, and he learned that “You don’t need to make it back the same way you lose it”. You don’t need to make back the money you lose, through the same holding(s).
What you do need to do is put the money to work. You need to put it into something or a few things that have a much better chance of providing positive investment returns over time. Investors must remind themselves that all decisions must be made based on logical reasoning and the results of conservative analysis using both qualitative & quantitative data.
The book The Snowball: Warren Buffett & The Business of Life, by Alice Schroeder, details Warren Buffett’s life experiences and how he picked up many of his investment skills and knowledge. I found it to be a very interesting read, as well as educational. It contains many small details such as the racetrack experience, not found in investment specific books. Most major bookstores carry it.
– Amazon.com Amazon.ca Chapters.ca
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