The stock market’s recent volatility means that many investors may currently be experiencing losses on some of their holdings. Contemplating whether to sell, hold or buy more shares in your loss-making holdings could be a productive use of your time. It may lead to a more efficient allocation of your capital.
Peter Lynch has a solid track record of managing his loss-making positions. His focus on company fundamentals and investing within his circle of competence may be key reasons for the 29% compounded returns of his Magellan fund between 1977 and 1990.
Reassessing a company’s prospects
Experiencing paper losses is a common occurrence for all investors. The stock market’s performance over the short run is unpredictable, and can mean that stock prices fall soon after they are purchased. However, failing to determine whether loss-making positions have the potential to recover over the long run may lead to an inefficient allocation of your capital.
For instance, in some cases a stock’s price may simply have fallen because of weak investor sentiment towards the wider market. In other cases, there may be new threats present that could make your holdings less appealing from a risk/reward perspective than when you purchased them. Therefore, it is crucial to ascertain whether there has been a change in the prospects for your holdings that could adjust your views of them from an investment perspective.
Lynch has previously highlighted the importance of reassessing company prospects when deciding what to do with loss-making holdings: “There's no shame in losing money on a stock. Everybody does it. What is shameful is to hold on to a stock, or worse, to buy more of it when the fundamentals are deteriorating.”
Investing within your circle of competence
Recent economic events have fundamentally changed the outlook for many industries. For instance, many retailers may now need to invest in their e-commerce offering due to a shift in consumer trends. Likewise, energy companies may shift their investment towards renewables as a result of lower oil prices.
This may mean that you struggle to obtain a full understanding of the business models of your holdings. They may now be outside of your circle of competence, which could mean that you are unable to properly judge their risk/reward opportunities.
Investing in businesses that you understand is key to generating high returns, in my view. Therefore, selling your existing holdings at a loss to reinvest in stocks with business models that are within your circle of competence may be a more efficient use of your capital.
As Lynch once said, “Your investor's edge is not something you get from Wall Street experts. It's something you already have. You can outperform the experts if you use your edge by investing in companies or industries you already understand.”
Tracking relevant information
The economy’s uncertain outlook may mean that it is tempting for any investor to spend their time seeking to predict its future performance. However, this may not be the most efficient use of your time when seeking to allocate capital while some of your holdings are experiencing paper losses.
A better idea could be to analyze your holdings from a business perspective to assess their chances of surviving an economic downturn, as well as their potential to adjust to changing trading conditions in the long run.
Company fundamentals may provide a far superior means of judging the appeal of your existing holdings than macroeconomic data or stock market charts. Company fundamentals may prompt you to sell loss-making positions to invest elsewhere. Or, they could indicate a potential mispricing that allows you to purchase more shares in the company at a lower price.
As Lynch once said, “Behind every stock is a company. Find out what it's doing.”
Read more here:
- Benjamin Graham on the Importance of Being a Rational Investor
- Warren Buffett on Adapting to a Chainging Investing Landscape
- Seth Klarman on Managing Your Time Efficiently
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
