No one likes seeing their hard-earned money being eroded.
It’s tough to endure the emotional pain of seeing your stocks fall in price.
As an investor, however, you should accept this as part and parcel of the investment process as even Warren Buffett, arguably one of the best investors in the world, cannot avoid losing money from time to time.
But the question is: what should you do about it?
On the one hand, a falling stock price could represent an opportunity to buy more of an existing investment at cheaper prices.
But on the other hand, the stock price decline could also signal that there is something wrong with the business.
When it comes to deciding if you want to average down on a position, the situation is never that straightforward.
What’s clear is that acting blindly based on a share price decline alone is not enough.
When stocks decline, the right thing to do is to stay calm and to analyse the situation.
Is it the right move to buy more, sell the position, or adopt a wait and see attitude?
Fear, hope and despair
Although it’s widely known that the stock market is a venue for companies to raise money, in reality, it’s much more than that.
The blinking stock tickers also represent peoples’ hopes and fears.
When money is involved, emotions will naturally run high.
Soaring share prices can ignite optimism that things will get better, feeding a virtuous cycle that causes prices and valuations to rise even further.
The converse is also true.
When share prices plunge, investors may feel a sense of despair.
Fearing that they could lose their entire investment, they may sell out of desperation to recoup whatever money they still have left.
When this selling occurs, it could trigger a vicious cycle where selling begets more selling which worsens as margin calls get triggered.
The above emotions explain why share prices can gyrate wildly even when the underlying business remains constant.
This brings us to the next point — finding out the reasons why the stock had declined.
Analysing the reasons for the drop
With a better idea of why share prices may be volatile in the short term, it’s time to analyse the reasons for the decline.
There are three possibilities here.
The first is that the company may be facing a temporary, one-off problem that negatively impacts its profit or cash flows.
A recent example was that of iFAST Corporation Limited (SGX: AIY).
The fintech group announced that they had purchased an 85% stake in a UK digital bank, BFC Bank, for S$73 million.
This bank, however, is loss-making and not expected to break even until at least 2024.
Investors reacted negatively and sold down the stock by nearly 10.8% to S$7.01.
But if you believe the acquisition will benefit the group over the medium term, it may make sense to add to your position.
The second scenario is when a company faces a more permanent, structural change in either its business or operating environment.
Take Singapore Airlines Limited (SGX: C6L), or SIA, as an example.
Over the last two years, the pandemic decimated air travel and plunged SIA into one of its worst crises.
The airline has, however, introduced vaccinated travel lanes that promise to improve passenger loads and utilisation.
But it may be a vastly different landscape that investors are faced with once the pandemic is behind us.
Investors have to evaluate whether these changes may permanently alter SIA’s prospects for the future.
Finally, the third scenario is when there is no news surrounding a company, implying that there is no logical reason for the decline.
Revisiting your investment thesis
It’s important to constantly check if an investment is still fulfilling your investment thesis.
This should be part of your investment process and is a sanity check as to whether you should buy more, hold or sell a position.
There is more urgency to do so when economic conditions are rapidly changing.
Revisiting your thesis can help you to make a more rational and logical decision.
If your investment thesis is no longer valid, it may be wise to think about reallocating the money to a more promising investment.
But if the thesis has not changed, you could decide to double down on the position to increase its weightage within your investment portfolio.
Get Smart: Doing nothing is also an option
You need not act upon every stock decline.
Remember that activity alone does not make you a great investor.
There will be cases where you should neither buy more nor sell off your existing position.
Doing nothing and waiting for more clarity or corporate developments is a legitimate move.
And that may sometimes be the best option for the Smart Investor.
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Disclaimer: Royston Yang owns shares of iFAST Corporation Limited.