Before earnings season took centre stage, I (Mat) wrote a little piece about my approach to booking gains. Naturally, questions began to pop up about cutting losses.
This is a far more complex question that is dependent on numerous factors. That being said, let’s see if I can provide a little more insight that might help you answer the question, when should I cut my losses?
First and foremost: You need to understand why you bought a stock in the first place.
Lets start with a widely known phrase by one of our favorite investing gurus here at Stocktrades Premium, Peter Lynch:
“Know what you own, and know why you own it”
If you don’t know the answer to that question, then it will be near impossible to know when to cut your losses.
Buying simply because you got a hot tip, saw it on Facebook, or because it was on a Stocktrades Bull List is not reason enough to buy/own a stock. One must always due their own due diligence and have their own thesis in the decision.
Now, we do realize that many members utilize our stock picks, and the bulk of their portfolios are a direct result of the stocks we’ve highlighted. However, we can’t stress enough that if you’re going to purchase a stock on one of our Bull Lists, you have to know why we highlighted it, and you have to agree with our investment thesis at the very minimum.
This is exactly why we develop our reports and update them every quarter. We receive constant feedback in terms of agreement/disagreements with our investment thesis on our Bull List picks. This is great, as it means members aren’t blindly buying Premium picks.
When I look at selling a stock (which doesn’t happen often) I tend to ask myself 3 key questions:
Question 1: Has the investment thesis changed?
Arguably, this is the most important question. If the investment thesis has changed (for the worse), then it may be time to move on.
Remember, you bought the stock for a reason and if that reason is no longer valid then you’ll either need to find another reason, or move on.
A quick example. You bought a company based on the fact it has produced strong double digit dividend growth over the last 5-10 years. However, it has recently downgraded its forward outlook in terms of dividend growth to low single digits. This is a prime example of a situation where you would need to re-evaluate.
Is the company reducing dividend growth guidance due to struggling earnings, or has it found opportunities to invest that capital back into the business instead of paying it out? And if the answer is the latter, as an investor you need to ask yourself if you’re ok with that, and possibly restructure your overall thesis.
This exact situation happened with Foundational stock pick, TC Energy (TSE:TRP). The company reduced dividend growth guidance as it sees more opportunities to grow organically with that capital. Which, we’re completely fine with.
Let’s use two more examples from our Bull List
That being Real Matters (REAL), and Goodfood (FOOD). In Real Matter’s case, it has been fighting downward momentum for the better part of the year. While there are macro events that are impacting it, the company has performed quite well.
It is delivering on expectations and is on track to meet 2025 guidance. While there are short-term headwinds, the investment thesis really hasn’t changed with this one.
It is for this reason that myself and Dan have held on to the stock through its downtrend. It’s important we understand that the price movement of a stock is not an investment thesis. While it may make sense in some situations to book profits in the case of significant price growth, over the short term the movement in a company’s stock price should never be validation of whether or not we’ve made a strong decision.
On the flip side, Goodfood was tracking quite well until this past quarter when it missed in a big way. While we expected growth to slow and for supply chain issues to have some impacts, we were not prepared for negative revenue growth and such disappointing results. In fact the company went from recording record revenue in the third quarter, to declining growth in the fourth. A significant, and very surprising, turn of events.
Throughout the pandemic, the company spoke about how industry growth accelerated. It also had an excellent track record against expectations. While the company remains cheap, negative growth changes the investment thesis in a big way.
Especially when one considers that Hello Fresh continues to grow and even raised guidance this quarter. Seeing as there is a strong possibility the company sees negative growth next quarter, there is much less certainty here.
On the flip side, it may be one bad report and it could return to growth next quarter. Unfortunately, there is now plenty of uncertainty here so those that hold it will need to have strong conviction that it was just one bad quarter. It’s a question that Dan (who owns Goodfood) must wrestle with as he seeks to rebalance later this year.
The overall uncertainty and change in the reasonings as to why we added GoodFood to the Bull List in the first place was the prime reason for its removal.
Question 2: Do you need the cash?
There are many reasons why one would sell a stock. Perhaps you just need access to cash. Everyone’s financial situation is different and even if the investment thesis hasn’t changed, there may be a need to sell the position for liquidity.
This happened to me a number of years ago where I liquidated my TFSA because I needed the cash for a project. I sold some winners and losers, but ultimately it was in response to my own financial need for liquidity.
The perfect strategy is to invest money that you don’t plan to touch for the next 5-10 years. However, we realize that we’re in the real world here, which is far from perfect. Expenses happen, business opportunities happen, or money is better placed elsewhere. However, if you don’t need the cash, then you are more likely in a position to hold those paper losses.
A good example of this was Ovintiv (OVV). At one point, Dan and I were sitting on 94% losses on the stock after holding for less than a year. The pandemic certainly accelerated this as oil and gas collapsed. Yet, we both continued to hold.
Why? Because the company underwent a few big administrative changes that the markets unjustly punished as well. We felt that the investment thesis hadn’t changed and neither of us needed the cash. We could afford to just let it sit – “dead money” so to speak.
However, things changed quickly. In a span of a year, that 94% loss turned into a 25% gain. Buoyed by a positive macro environment for oil & gas combined with significant undervaluation, the stock eventually rewarded us.
Question 3 : Is there a better investment opportunity elsewhere (opportunity cost)?
By definition, opportunity cost represents the potential benefits an investor misses out on when choosing one option over the other. Sitting around waiting for a recovery in stock ABC when it could be invested into promising stock XYZ is a prime example of opportunity cost in the stock market.
There will always be opportunities in the markets. Whether we are experiencing bearish or bullish sentiment, there is likely always something out there that will look attractive. So perhaps, you’ve identified an opportunity that can yield greater returns than the one you are currently waiting to rebound.
Now, I say this with a strong caveat. The grass is not always greener on the other side. It can certainly feel this way when you have a struggling position inside of your portfolio. In fact, virtually anything can seem like a better opportunity.
However, I’d caution against jumping from position to position, especially if the investment thesis on your current stock hasn’t changed. Circling back to the Ovintiv example, we’d have been hard pressed to find a stock that returned as much as OVV did in such a short period of time.
That being said, there may be opportunities that you find are just too good to pass up.
I ended up selling one of my microcap losers to pick up Bull List stock Enghouse (ENGH) a few months ago when it was hammered following earnings. The stock I sold was a speculative one and while the investment thesis hadn’t necessarily changed, the opportunity came and it was one I felt that I could not pass up.
Worth noting, I never would have sold that position for another microcap opportunity. I made the move because microcaps were struggling and Enghouse is a much stronger, reliable performer that was suffering from a market overreaction. It’s one of the most successful tech stocks in the country.
It is also important to make these decisions in context with your own risk tolerance and portfolio allocation. Be mindful of swapping positions frequently that will alter the makeup of your portfolio.
There is a common phrase in investing:
“Your portfolio is like a bar of soap. The more you handle it, the smaller it gets.”
Every move an investor makes should be done within the context of their own risk profile.
Only you can answer these questions.
These are difficult questions to answer, and they are individualized. This is why when someone asks us “should I sell stock XYZ”, we can’t provide a definitive answer.
If we hold the stock, we certainly have no problem letting you know what our approach is, but once again that is within our own context. Just because we decide to hold or sell a stock doesn’t mean you should. This is exactly why you need to know what you own, and why you own it.
Here are a couple of other key points to remember:
– If a stock loses 50% of its value, it will have to double in order for you to break even. Once we hit 70% losses, you’ll need 233%. Once we get to 90%? You’ll need a 9-bagger, or 900% to recoup your initial investment.
– Be mindful of making changes during large macro events. Perfect example right now is the global supply chain issues. This is impacting so many companies at the moment. While the investment thesis may change over the short-term, once these issues are resolved the long-term thesis remains intact. So making short term moves could lead you to miss out on a rebound that could come fast and quick.
Dividend Bull List selection & a BRAND NEW feature to Stocktrades Premium
We’re putting the final touches on a brand new Dividend Bull List report, a company that we feel provides a unique opportunity in an inflationary environment as well as a high starting yield for investors. Look for this in the next few days.
And, we’re set to release some information on a brand new feature we have coming to Stocktrades Premium in the new year, one that has been requested extensively by current members. Look for this later in the week!
As always, head to the Q and A and the Discord to discuss this weeks e-mail! If you aren’t sure how to join the Discord, watch this video
