“The desire to perform all the time is usually a barrier to performing over time.”
~ Robert Olstein
Every single stock I purchase in my account is set for a great future… or so I think each time I add another company to my portfolio!
The problem comes when after a few months the stock underperforms. A couple of quarters later, I now show a double-digit loss on my investment. The following year, I’m still sitting on this pile of “dead money”.
Where is the Source of the Problem?
The first question you must answer is what the source of this debacle is. First, save yourself some time and check if it is:
- The market
- The sector
- The company
If the entire market is down as it was during the second half of 2018 or in March of 2020, then look at how much your stocks are down. Everything that moves in a similar way to the market in total doesn’t deserve your immediate attention. It’s only normal.
Then, you can identify if it’s because a sector has been hit by a specific event.
In March of 2020, the oil & gas industry had been hit by two events in the same month (this is what we call a perfect storm!). First, the pandemic pushed the entire market down. Then, OPEC decided to flood the market with cheap oil.
In this chart, we clearly see the energy sector getting hammered a lot harder than any other sectors. Whenever an entire sector crumbles, you must assess the situation. What is going on and why? In this case, we saw demand for oil declining drastically due to the lockdown combined with an increase of offerings from OPEC. If you go back a few years in history to add some perspective, you will notice a similar offer/demand crisis happened back in 2014-2016. The energy industry has gone through three crises in eleven years.
Do you think companies are strong enough to thrive going forward? The answer to this question will help you determine what the possible outcomes are for the coming years in this sector.
Finally, it is possible that you are holding the underperformer of a sector and this company has its fair share of troubles. A good example would be IBM in the tech industry. While most tech stocks thrived over the past 5 years, IBM has struggled consistently to post growth. IBM reported 22 or 23 consecutive quarters with revenue declines. That was quite an achievement in the wrong direction!
I’ve discussed the IBM case and how to prevent holding losers in the video below:
What Should I Do Now? Sell or Wait?
First rule: never sell your losers because you lose money.
Second rule: never keep your losers because you lose money.
Selling a loser is first and foremost an admittance that you were wrong. Nobody likes being wrong, especially when it means losing money. Denying the problem and keeping your losers forever is a self-destructive way to avoid the cold hard truth.
When we get hit with a 40%+ loss in our portfolio, many of us will be tempted to keep it for a while. I’ll keep my shares until I recover a good part of my losses. Bad decision. Don’t believe me? Let’s dig into this fairy tale.
The Breakeven Fairy Tale
Let’s take a moment to look at what happens when you lose money on an investment. This table will show you how much return you must generate from an investment that suffered a great loss.
| Original Value | % Loss | $ Loss | Present Value | % to Break Even |
| $10,000 | 10% | $1,000 | $9,000 | 11% |
| $10,000 | 20% | $2,000 | $8,000 | 25% |
| $10,000 | 35% | $3,500 | $6,500 | 54% |
| $10,000 | 50% | $5,000 | $5,000 | 100% |
Please not that the more you lose in %, the required rate of return to break even is increasing exponentially. This is how your energy stocks will require you to generate a stock return of roughly 100% for each of them that dropped by 50% only to recover back to your initial investment.
Now, what are the odds you will see your investment bouncing back that strongly in the next 5 years?
That’s correct; it depends on the investment and the situation. But overall, chances aren’t that strong. In many cases, you will hold onto your big losers for several years until you finally drop the towel and move on.
If you refuse to sell for too long, you suffer even more. First, you lost your money on a bad investment. Second, you take the risk of losing even more. Tell that to those who kept their shares of Vermilion Energy (VET) after the first drop of 2016. Third, you keep losing money by keeping your dead weight instead of investing your monies in a more profitable stock.
The costs of waiting are insidious. They hurt your portfolio like an infected wound. You must act.
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Yeah. I sold my loser OMI back in fall 2019 after it was trading for half of what I paid 18 months earlier. One of the only stocks I sold in years.
Six months and one pandemic later its trading at 27.50 (it was 30$, 4 times what I sold it for!
Agreed. Its sometimes best to sell your losers, crystallise your losses and use this to offset capital gains on your winners.
I keep around losers in case of a forced sale. When I do sell them, I might sell a little more to offset regular income. Thanks for the article!
That is why you should implement stop-loss orders according to your risk tolerance.
Even when you’re posting a profit.
That way, you some of your profit and your capital back. The table in this article is really telling. If you let things slip to -50%, the chances of that stock doubling in price (100%) are very slim indeed.