By Chee Jo-Ey
IT’S typical of stock market indexes to move higher over longer periods of time but individual stocks don't necessarily follow and there are some that can experience continuing periods of losses. The ability to recognise a capital loss is what makes one a successful investor.
According to iFAST Capital analyst Jerry Lee, for those investing directly into stocks, understanding the nature of the business is crucial. Investors have to identify the factors that have caused the drop in the stock prices. Sometimes, the selloff could be due to the market uncertainty which could be driven by emotional factors.
The reason behind the decline and what the company that they have invested in does are the two most important factors for one to consider before deciding whether to trim one’s exposure in such a company.
It really depends on the kind of instruments one is leveraging on for investments.
For example, if one is using the unit trust fund to invest in a stock market, one should understand the market and analyse the fundamentals and valuation of that market. Some investors even look into the sectors the fund is invested in and analyse the sectoral outlook.
Dr Eric Koh, a senior lecturer at the department of finance and banking at University of Malaya, advises investors to consider the aim and planned time horizon you had when you bought the stock. Also, ask yourself if this is a temporary dip or a longer term fundamental one.
“If it's a temporary fall and you have sufficient resources, liquidity and time horizon tolerance to pull you through, perhaps it's alright to hold on for a while. In fact, if you believe it's really a short term blip and if you believe that its target price has some good upside potential, you may even see it as a good time to buy more,” Koh adds.
Of course, it's good to have some indicative base towards which you would want to cut your losses. Conversely, if it's a longer term dip, then investors may also wish to cut their losses at some indicative base.
A mistake investors often make is to quickly sell when there's actually a market aberration or to buy when it's on an upward price momentum.
FSMOne research analyst Shawn Low said, “An investor should study the stock closely and think if the reason why he bought the stock in the first place still applies. If the business prospects remain intact and the company has enough resources to tide over the current period, then the investor should be comfortable to hold on to the stock.”
However, if the stock’s business prospects have changed drastically and may not have enough resources to tide over the current Covid-19 crisis like in the tourism-related industry, then investors should bite the bullet and cut the loss.
Different companies in different sectors would have their own terms of arriving at their fair valuations, according to Low.
For most, it would inevitably involve estimating future earnings and the price to earnings (PE) valuations.
Typically, if the earnings are expected to fall significantly and may not rebound in subsequent years, the forward PE would become higher, indicating expensive valuations. In such circumstances, the fair value of the company should be adjusted downwards and if fair value turns out to be even lower than the fallen stock price, it makes sense for investors to get out.
“In extreme cases, some companies may be experiencing a double whammy where they have significant debts to be repaid alongside the drop in business. Investors should take a look at the balance sheet of companies and stay tuned to the quarterly earnings updates from the listed companies to see if the company would have enough liquidity to tide it through this year.
“Earnings prospects and balance sheet conditions would be key areas for investors to decide if he or she needs to sell a stock that has dipped,” says Low. - May 4, 2020