The last month has reminded us that the threat of loss is part of investing. It is human nature, we all remember your winners, the stock that saw a quick doubling, the brilliant picks that make us go, "hey this stock market thing isn't so hard". However, however lost in the bottom of the draw full of trade statements and schedule D filings are the losses, the ones where we misread the winds of change or the quarter just did not work or the market had no patience. I am not talking about the cases of a few points up or down, or a bad week on the market that drops everything by a percent or two for a bit, or even the world is ending type of drops we saw in 2008, but the "I can't believe this is happening … I lost 25% in a few days … it crashed without warning…oh, why me" type of drop in a stock that every investor probably sees at least once in a blue moon.
Many of us tend to let our investment successes run; a significant loss however begs to be sold off for a capital loss every time we look at it, and to move on, with a bad taste and memory for the stock that let us down. And there, we lose a lesson that is worth discussing. If you run your own portfolio, which probably includes most of the SA community, you have developed the smarts and experience, and most significantly the ego to put your money up against the behemoth that is the market. Having put some of my money in my contrarian "fear and loathing" portfolio as discussed in other articles, I have seen some share of losses and disappointments. Where many of us fail is in taking some knowledge and maybe a bit of profit against our losses.
So of possible interest, let me share three ways to approach losses.
- Keep your losses as close as your winners. I always keep a small piece to remind me - while it is always tempting to sell out and move on from a loss, there is one advantage to keeping a small keepsake of the stock. Even one share retained in a portfolio is a memento that all are fallible and that there is a certain amount of rolling the dice in every investment. It is also an incentive to keep tabs on that stock that you once thought was brilliant, it may someday be worth considering. Of course, just keeping the stock symbolical on your watch lists may keep it in your sights, but there is an emotional note to still having ownership that gives it more significance. I have used this approach to advantage of several investments. I sold most of R.R. Donelley (NASDAQ:RRD) after they tanked on mishandling some Google information, but by keeping track of the stock, decided later to buy back one once it became clear that it was not going to be a show stopper for them, and have ridden it back up to a nice profit. Likewise Marvell (NASDAQ:MRVL) was a stop loss after they lost a billion dollar patent lawsuit, but by keeping track of a handful of shares retained, was reacquired for a nice continuing profit. Would I have kept up with these stocks if I did not keep a small position?
- In a retirement accounts, loss history does not matter. Since there is no option and tax incentive to take a capital gain or loss in a retirement plan, every stock needs to be considered at the moment; how much you paid for it, how much it has moved since it was acquired is moot. As such, I have found my stocks in retirement accounts to be purchased with more consideration to protection from risk of a downside than in non-retirement accounts. This forces a more balanced look at stocks when they do go south, since you are evaluating them with the eye of "would I still purchase this today". For me this is a tradeoff of the bad news causing a loss, vs. virtues of the stock (book value, dividend, prospects) at its new price point. This point of view has helped to keep Linn Co (NASDAQ:LNCO) in my 401K thru several dramas in 2013 - the value and dividend just got more compelling as the stock kept tanking. It keeps me invested in and even adding to Centurylink (NYSE:CTL) today, as a dividend and value stock that the market does not believe in, but that makes sense to me.
- Have faith in regression to the mean - As shown in studies and the experience of many investors, both the statistical nature of stock movement and the psychologies of investing support regression to the mean. In order words, stocks that have large movements, both positive or negative, tend to adjust back to their mean trend in stock performance. Not always of course, but often enough that the thought should be considered before pulling the trigger on any loss. In particular, for stocks with significant book value assets or supportable cash flows, and where the stock price has dropped due to isolated events and /or management has the smarts and tools/options to change the situation, a sustained price drop may be an opportunity to replace or even increase a position for the future. Obviously this is not a strategy that can be practiced in isolation, there are certain stocks and industries (coal being one example to me) where the business equations have changed such that mean performance for past value does not seem to hold for the future. However, we can see this in the examples above (still in progress with CTL) as well as doubtless ones from your own experience (please share) where significant losses can be setting the stage for future gains.
These observations may seem common sense to many of us, but they are worth remembering. They are observations, and not rules (I hold a share of Boston Scientific (NYSE:BSX) still waiting to its recovery from wonderful on paper but otherwise disastrous merger with Guident in 2005), but have worked in practice. It is always interesting to see comments and even articles in SA and elsewhere over the years, where stocks have been (irrationally) demonized for (irredeemable) sin of a (unrecoverable) loss. While no doubt cathartic, it may be wiser (sic) to understand a stock that has taken some significant losses plants the seeds for candidates for future investments.
Disclosure: I am long RRD, MRVL, LNCO, CTL, BSX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.