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The best way round this is to draw up a plan of precisely what actions you will take when your investments don’t work. The Rabbits didn’t have one. You can.
The only solution to a losing situation is to sell out or significantly increase your stake.
“If I had a blank piece of paper and were looking to invest today, would I buy into that stock given what I now know?” If your answer to the question above is “No”, or “Maybe, but…” then you should sell.
“[E]very few months I checked the story just as if I were hearing it for the first time … [and I would] get out of situations where the fundamentals are worse and the price had increased … and into situations where the fundamentals are better but the price is down … a price stop is any opportunity to load up on bargains from among your worst performers … if you can’t convince yourself when I’m down 25% I’m a buyer then you’ll never make a decent profit in stocks.”
A corollary of the previous point is to never put yourself in a position where you find you are still convinced by your original investment idea but are not able to invest more money when the share price falls. That is poor money management. Keep some powder dry. This also helps neutralise the denomination type of effect – of feeling an investment is too big to be changed.
“[W]hat separates the winners from the losers? The answer is simple – the winners make small mistakes while the losers make big mistakes.”13
Here are some of the excuses I have heard over the years: a) The ‘If only’ defence. b) The ‘I would have been right but for’ defence. c) The ‘It just hasn’t happened yet’ defence. d) The ‘Who could have foreseen at the time I invested that XYZ would happen … ’ defence. Peter Lynch in his book One Up on Wall Street lists the 12 silliest (and most dangerous) things people say about stock prices. Some of these are well worth including here too: e) If it’s gone down this much already, it can’t go much lower. f) You can always tell when a stock hits rock bottom. g) Eventually they always come back.
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believe that even the best investors often overlook the fact that a stock’s price would need a practically supernatural rise of 900% to break even if they have foolishly ridden it down 90% and done nothing. Losing 50% means you need a return of 100% to break even.
For those of you who are curious to know whether the Rabbits recovered their money from staying invested in their big losers, let me satisfy your curiosity. Of 131 investments that fell by more than 40%, only 21 went on to produce returns of over 100%. Odds of ⅙ are not great. And not one produced the required returns to get back to breakeven.
poker. Any poker player knows that it is not how many hands you win that matters, it’s how much you win when you win, and how much you lose when you lose.
Table 1: The impact of losses Percentage loss Gain required to break even -10% 11% -20% 25% -33% 50% -50% 100% -75% 300% -90% 900%
DATA POINT: A 33% limit A loss of 33% requires a 50% subsequent return to break even. My findings show only 11% of the winning stocks (101 in total) that my top investors made produced realised returns of more than 50%. Only 21 of investments analysed realised a return of over 100% – 1% of the investments made Price targets and a predisposition to snatching profits when winning (see chapter 4) help explain why so few big winners were realised. The reality is, many stocks go up hundreds or thousands of per cent, but few investors stay invested for the duration of the ride. Most sell once they
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In the world of investments there is no such thing as a safe bet. If you invest in a company and think that it is bulletproof, I urge you to have an action plan to decide what to do when things go wrong – things often do.
Overall therefore, 594 (389 + 205), or 63% of losing stocks went on to produce a return of less than 20% post-sale, with the majority of those losing money. As a result, only 352 (946 - 594), or 37% of stocks that had lost the investor money when he sold went on to return more than 20%. In conclusion, two-thirds of the time you are likely to be better off cutting a losing position.
The Assassins’ second rule was therefore to sell stocks which went down by any amount and showed no signs of recovery after a certain period of time.
The majority drew the line at six months, but there were variations,
Analysing the figures, 64% (607 bad buys) were sold within six months of initial purchase, whilst 42% (397 bad buys) were sold within three months. Only 17% (157) of bad buys were held for longer than one year. Indeed, 99% of all bad buys were sold within three years. Stated more starkly, only 12 investments that were realised for a loss were held for longer than three years. Most professionals sell quickly. I am sure some of that is down to outside pressure from clients or bosses, but even a reluctant Assassin is better than an unrestrained Rabbit.
DATA POINT: Whipsawed sore Of the 1,866 investments made by my top investors, 421 (22%) were realised for a loss of up to 10%. I discovered that 249 (59%) of these went on to make money. This suggests that if you cut your losses after suffering a minimal loss, you are probably going to be whipsawed. Moreover, a 10% loss is something that is easily recoverable, even if you have a disposition to take profits when you have made a mere 20%.
However, lack of an alternative compelling investment is no excuse for continuing to have money tied up in a low-conviction losing position. Having money sitting in cash gives you an option. Always having your nose in the trough can be very dangerous. As the Wall Street saying goes: “Bulls win, bears win, but pigs get slaughtered.”
“In life and business, there are two cardinal sins. The first is to act precipitously without thought and the second is to not act at all.” – Carl Icahn “There are risks and costs to a program
The way I remember the importance of avoiding big losers is perhaps not very Assassin-esque. I do it with a simple Post-it note. It’s stuck to the edge of my computer monitor and it says: Losers hang around with losers while winners hang around with winners.
Be under no illusions: being a Hunter requires patience and discipline. You have to expect a share price to go against you in the near term and not panic when it does. You have to be prepared to make money from stocks that may never recapture the original price you paid for your first lot of shares. If you know your personality is one which demands instant gratification, this approach is not for you. “I’m accustomed to hanging around with a stock when the price is going nowhere. Most of the money I make is in the third or fourth year that I’ve owned something.” – Peter Lynch
If a stock you are invested in has fallen materially in price, but nothing else has changed – the investment thesis is still in tact – your odds will have improved significantly and you should materially increase your stake in that company.
If you are a Hunter, though, you choose not to control risk by diversification but by thoroughly understanding the risk and returns of a particular stock or handful of stocks. Your goal is to find companies that have an unbelievably attractive, asymmetric payoff profile.
the businesses he understands best and that present the least risk, along with the greatest profit potential.
The Hunter adopts the three-bites-at-the-cherry approach to investing, which means that he initially invests a third of the total amount he is willing to invest in the stock. If the price falls beyond a certain threshold, he invests another third. If the price falls yet further, he will deploy his final third of remaining capital in the stock.
Moreover, the most successful investors I worked with, those that made the most money, all had one thing in common: the presence of a couple of big winners in their portfolios. Any approach that does not embrace the possibility of winning big is doomed.
All the successful investors I have managed made money because they won big in a few names, while ensuring the bad ideas did not materially hurt them.
