Why You Shouldn’t Cut Your Losses When Your Portfolio Falls

If you were part of the heady Hang Seng Index bull ride in 2016-2017, chances are your stock portfolio has been showing a loss since 2018. Amid the market’s uncertainty and bearish sentiments, it can be unnerving to watch your losses grow.  But before you give into the urge to cut those losses now, let us show you why that’s not necessarily your best course of action.

The Bigger Picture

The Hang Seng Index reached its historic high on Jan 29, 2018 at 33,484 points.  Since then, the market has slid into bearishness, with the HSI hovering around 25,000-26,000 points at the time of writing.  On an annual basis, in 2018 the HSI fell 15% compared to 2017.

This is of course intricately related to the performance of the Chinese market.  The Shanghai Composite Index closed the year 2018 at 2,494 points, down 25% compared to 2017, whereas the SZSE Component Index is down 24%.   On the other side of the globe, the US market witnessed the worst Christmas Eve trading session ever, when the Dow Jones Industrial Average plunged more than 650 points.  Despite a sharp recovery on Boxing Day, the Index fell6% in 2018 vs 2017, leaving investors wondering whether the United States’s historic 10-year bull market has ended.

2019 will likely be bearish.  But for value investors, this spells opportunity, not disaster.

Business Fundamentals

When you decide whether or not to sell a stock, make business fundamentals your most important consideration. Read through your company’s latest financial report, and try to evaluate its business outlook and earnings prospects against the current macro environment.   Has anything changed?  Do recent key happenings, such as the trade war, have any impact on the business’s fundamentals?

Suppose you own shares of a property developer whose price has dropped 20% since its peak in January 2018.  Its future earnings might indeed face some setbacks; sales of new properties will likely be sluggish in the coming year.  But if its fundamentals (e.g., land bank reserves, debt-to-equity ratio, cash flow) are all solid, its prospects shouldn’t have changed much.  Unless you are extremely pessimistic on the long-term economic outlook of Hong Kong and China, you have no strong reason to sell the stock, despite its falling price.

Conversely, if a company is facing structural challenges that will likely depress its earnings for years to come, it’s time to consider selling. For example, sectors at the core of the trade war will likely face a rough ride ahead – most notably IT hardware and precision manufacturing companies.  These challenges are fundamental in nature, because the rules by which these companies operate will be rewritten according to the outcome of the China/US trade negotiations. That uncertainty weighs heavily on these stocks and their future.

Dividends

Provided the company has sound fundamentals, the next checkpoint is dividends.  Does the company have a long history (i.e.,10 years or more) of consistent dividend distribution?  To ensure that a company can sustain its payouts, you need to look at its financial strength, ensuring that strong operations support that dividend.  Look at the latest financial statements.  Are there unusual liquidity changes, like a significant increase in debt or a decline in free cash flow, that might endanger the company’s ability to pay its current dividend?  Sometimes, a sharp rise in yield can signal that major shareholders are cashing in as an exit strategy.

P/E

What if the company you own passes the fundamentals and dividends test, but you bought it at a very high P/E, which has since come down a lot?  If you are convinced about that company’s quality and prospects, consider taking advantage of the market correction to increase your stake in the company.  Buying more at a lower price will bring down the average purchase cost of your shares. And you might stand to gain more when the bear market is over.

Scout for Opportunities

For value investors, bear markets are a time to buy.  Start tracking high-quality companies with strong fundamentals.  They should also have attractive P/Es (15 or below) and yields (5% or above).  Put these stocks on a watchlist.  Be patient. Once you decide to buy, buy in batches over a period of time.    As no one can predict how long the bear market will last, buying at different price points reduce the risk by averaging out your cost of purchase.

In a bear market, most investors succumb to fear.  Holding stocks as they slide from gains to losses can feel painful and frightening.  But sensible investing requires you to put those emotions aside, and evaluate whether these stocks are good businesses worth owning.   If you have been investing with this mindset, you’ve got little to worry about, even in the most bearish market.

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本文所提供的信息僅供一般參考之用,並不構成任何個人化的投資勸誘或建議。作者沒持有以上提及的股票。
HK MoneyClub (www.hkmoneyclub.com)