Gains and Losses

Several years ago, I had been watching the stock of a local company; it had been floating around six or seven dollars a share. The farm economy took a downturn, and with it the share price. When it got to four dollars a share, I thought “It can’t go much lower; now’s the time to buy”, so I bought one thousand shares. Well, it could go lower, and before I knew it, the stock was selling at about one dollar a share.

Had I just lost three thousand dollars? One of the axioms of stock buying is “don’t chase your losses; cut them before they become too bad”. But I didn’t have any better investment ideas, and the company seemed to be percolating along ok, so I just kept the stock.

Times changed, the economy improved, and the stock price started going back up. After a while, it hit nine dollars a share. <i>Had I just made a five thousand dollar profit?</i> But I hung on to the stock, for sentimental reasons as much as anything else.

The share price started drifting back down, eventually hitting just under six dollars a share, and is now drifting back upwards.. If I sold the stock now, I would have an annualized gain of about 10.6 percent. If I had sold the stock six months ago, I would have had an annualized gain of about twenty-five percent.

There are some thoughts that come to mind from this tale. First, when the stock was at a dollar, why didn’t I buy more? Well, when you’ve seen that precipitous a drop in stock price, even though the whole market was going down, you wonder if there’s something else going on that you don’t know. Would you be throwing good money after bad? Alternatively, why not sell it and chalk it up to a bad investment? In this case, the company did not seem to be floundering, management seemed to be managing ok, and since the stock market in general wasn’t doing too well, I just hung on.

Second, when the stock hit nine dollars a share, why didn’t I sell it? Mainly, there are sentimental reasons springing from knowing people who work at the company; also, would it continue to hover around nine dollars, or was this just a short-term peak, as it turned out to be?

There are several lessons to be learned from this story, I think. The price of a company’s stock may go up or down for reasons totally unrelated to the company’s performance, or at least totally out of proportion to that. Also, your profit or loss on a stock you’re holding is meaningless until or unless you decide to sell it. “What ifs” of course you always keep in mind, but don’t go stomping around the house because a stock price went up or down. Further, be truthful with yourself about why you are holding a particular position. If it is because, as in this case, you feel a loyalty to a local company, acknowledge it to yourself and realize how you are limited by that loyalty.

If this had been the first or only stock someone owned, I could see an individual becoming totally disheartened about the stock market. And this is the real point of the discussion: price moves like those described above should not be a cause for panic, but rather a cause for a realistic assessment of what you expect to get from a stock purchase, in light of all the current conditions.

As you build up a portfolio of stocks and mutual funds, though, you should also build up a discipline of when to buy and when to sell. I had been watching the stock of an internet services company. Quarter over quarter and for the last couple of years, its income and profits had been steadily rising. At 96 cents a share, I bought a thousand shares. Four months later, my stock had gone down to 81 cents a share. Another internet services company has been advertising heavily for business in the same market, and whether the other company could sustain its busines in light of heavy marketing costs or not, it seemed unlikely that my company’s  stock price would recover anytime soon.  Actually, since my sale, it has come back up to 88 cents a share. However, I did invest the proceeds of the sale in a company that pays a twelve percent dividend in a relatively low-tech sector of the market, and I think I will feel comfortable with that for a while. As the Kenny Rogers’ song says, “You gotta know when to hold’em, know when to fold’em”.

If you are a full-time investor, you should be learning these lessons early and quickly. If most of your working time is in some other endeavor, these lessons may come less rapidly, but you should be learning them nonetheless.

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