Performing the necessary research and due diligence before buying a stock is the responsible thing to do.
After all, you are deploying your hard-earned money to enable it to grow at a rate higher than inflation.
The business world, however, is inherently unpredictable and is affected by a myriad of factors.
Despite your best intentions, there will be times when your investments do not go your way.
Businesses may face increased competition or lose their competitive edge, causing their share prices to plunge as profits and cash flow fall off a cliff.
Most investors would have experienced a plunge in the value of their investments throughout their investment journey, myself included.
The question is – what should you do and how should you react when this happens?
Is it an opportune time to buy more, or should you get rid of the underperforming stock?
Let us dig deeper to find out.
A solid franchise hit by temporary headwinds
A company could be hit by temporary headwinds that depress its stock price as investors turn pessimistic.
However, the key to ascertaining if it should still stay in your portfolio is to look at its competitive moat and track record.
If the business maintains a solid franchise but is experiencing short-term troubles, then it should rebound in due course.
Investors need to assess if their original investment thesis remains valid in light of the new information and make a decision accordingly.
Should the challenges turn out to be temporary, it represents a great opportunity to scoop up shares on the cheap.
Warren Buffett’s famous quote says that you should “be greedy when others are fearful”.
The caveat here is that this line only applies to businesses that stay strong as they can eventually recover and go on to do better.
A recent example of a stock that lost more than half its value is Meta Platforms (NASDAQ: META), the owner of social media sites Instagram and Facebook as well as the chat messaging platform WhatsApp.
From early January 2021 to November last year, the share price of Meta plunged nearly two-thirds from US$268.94 to US$90.54.
As the pandemic receded, many technology companies were faced with declining demand after the initial surge back in early 2021.
Despite this headwind, CEO Mark Zuckerberg declared 2023 to be a “Year of Efficiency” and went on to lay off more than 21,000 staff.
Meta’s latest fiscal 2023’s first-quarter earnings presentation also showed continued year-on-year growth in daily and monthly average users, putting to rest concerns that growth was stalling.
Since touching the low back in November, Meta’s shares have rallied nearly 242% to close at US$309.34.
Structural problems
Meta’s example above demonstrated a solid business that fell prey to short-term headwinds.
Some businesses, however, encounter structural problems that cause the business to deteriorate to a point where it may be nearly impossible to recover.
Take Peloton (NASDAQ: PTON) for instance.
The exercise equipment company enjoyed roaring business during the pandemic when restrictions forced many to work out from home using its equipment and software.
Shares peaked at around US$162 back in December 2020 but by late October 2021, the share price had fallen by 43.6% to US$91.44.
Peloton went on to slash its full-year sales forecast by up to US$1 billion as demand fell sharply for its treadmills and bikes.
Shares went on to plunge 31% as more people hit the gyms and competition intensified.
The company replaced its CEO John Foley with former Spotify (NYSE: SPOT) CFO Barry McCarthy but this has failed to reignite the business.
For the first nine months of fiscal 2023 ending 31 March, Peloton reported a 25.7% year on year decline in revenue to US$2.16 billion along with a net loss of US$1 billion.
Shares last traded at US$9.47, a far cry from the heady days of late 2020.
Hindsight is 20/20
Of course, hindsight is always 20/20 and you can argue that these cases are only clear after the fact.
But what you can do as an investor is to assess the business characteristics to ensure that its success is no flash in the pan.
If a business has an enduring competitive moat, it is more likely to recover when the headwinds have subsided.
Get Smart: The choice is yours to make
You have three choices to make when your stock loses half or more of its value.
The first is to sell the stock to prevent further losses, as in the case of Peloton when it first reported a sharp decline in demand.
The second will be to buy more of the stock when valuations are depressed, as in the case of Meta Platforms.
A third option will be to sit and do nothing but continue to monitor the business.
Always remember to base your investment decision on business fundamentals rather than share price and you should not go too far wrong.
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Disclosure: Royston Yang does not own shares in any of the companies mentioned.
