Personal Finance | Don’t sell for the wrong reason

-

In April 2018, an investor called Vivek posted the 10-year return of three stocks on X, using Moneycontrol data. Over the period from 2008-18, he revealed the compounded annual growth rate (CAGR) of RIL (2.4%), SBI (1.02%) and ABB (-1.89%). This month, he revisited this list on, looking at the 7-year CAGR from 2018 onwards: RIL (18%), SBI (19%) and ABB (27%).

There is something every new stock investor should understand. If due to the stock price, your investment has run into a temporary loss, it does not mean you made a mistake. Just because you are losing money on a stock doesn't mean that you were wrong for making the investment. In fact, it is during such periods of apparent losses when you can average the cost of purchase, if you believe the business is fundamentally sound.

You make a mistake when you buy without understanding the business. You make a mistake when you do not do the due diligence before parting with your money. You make a mistake when you buy in a bull run and assume that everything will only go up. You make a mistake when you buy without a margin of safety. The point I am making is, do not conflate loss with mistake.

I think this is best explained by American financial analyst, investor and advisor Thomas Phelps. Way back in 1972, he posted some interesting examples in his book “100 to 1 in the Stock Market”.

Phelps created a table of basic financials for Pfizer over a 20-year period.

During this time, Pfizer sales went up 6.7x over 20 years, earnings increased 4.7x, dividends climbed 3.5x and return on shareholder funds was consistently high, averaging close to 17%. An investor only focusing on those figures would not have jumped in and out of the stock.

However, if the investor only focused on Pfizer’s price, the picture would have been different and chances are he might have not hung on to the stock. The stock had highs and lows, and significantly underperformed the market over a 5-year stretch during that period. And those who would have chosen to measure performance quarter by quarter - or even year by year--would have bailed out on the stock. A very costly mistake, because the stock went up 25x excluding dividends over those 20 years.

He recalls what his friend Karl Pettit, a wealthy investor and landowner narrated about his investment in the Computing-Tabulating-Recording company, which later became IBM: “In 1925, I personally owned 6,500 shares. At that time there were only 1,20,000 shares outstanding. I sold mine for more than a million dollars. Today (this book was written in 1972), they would be worth $2 billion.” Karl went on to very philosophically and wisely say that except to learn from experience one should never waste time looking back.

Selling too soon can be a frightfully expensive error.

So here is some advice Phelps imparts on keeping those emotions in check.

• Focusing on the price of the stock also gets emotions in the way of decisions. Stocks look best to so many of us when their prices are highest and worst when their prices are lowest. And that tempts us to buy wrong and sell wrong.

• When it comes to whether or not you should hold your stock or sell, the current stock price should not be the determining factor. Focus on earnings power. Stay with your successful stock investments as long as the companies are increasing their earnings. Good assets are also potential earning power, even if those assets are earning nothing at the moment.

• Never take an investment action for a non-investment reason unless backed by a lot of research. Examples of the non-investment reasons are: my stock is too high, my stock is not moving, new management, new competition.

• Don’t think too much about what the market direction is or will be. Most investors are less involved in deciding which stock to buy or sell, and more involved in deciding the direction of the market. Far more money can be made by good stock selection than by good stock market timing.

• Buy-and-hold should not be blindly done. The mere fact that a stock has been a growth stock for 10 or 15 years is no guarantee that it will continue to grow even one more year. There is no assurance that the stock will be a leader forever. Tomorrow is a new day for every company, every security. Eternal vigilance is the answer. Buy right and hold is to counter unproductive activity, not to recommend putting them away and forgetting them.

Larissa Fernand writes on personal finance and investing. She focuses on understanding the mindset of investors and their relationship with money. Views are personal and do not represent the stand of this publication.