One of the toughest decisions in investing is what to do with your losers. In some cases, today's losers can be tomorrow's stars. At other times, they are perennial dogs -- or worse.
Value investors are typically more patient than many traders are. But, sometimes, they can be patient to a fault. In order to avoid becoming one of the latter, I advise setting and following guidelines. This article, and another to follow next Tuesday, will explore my recommended criteria for distinguishing between well-founded patience and detrimental inertia.
When is it advisable to hold on to a losing stock? Generally, I would advise doing so when most of the following factors apply:
● Your original investment thesis for buying the stock is still valid, but the stock has been overshadowed by one-time events, economy-driven factors or market psychology.
● The stock has strong valuation support -- that is, it sells at a very depressed valuation per a low price-to-earnings, price-to-sales, and/or price-to-book value, and carries an attractive dividend yield. Compounding this support would be favorable intermediate- to long-term business prospects. This valuation support can be on a relative as well as absolute basis.
● Management seems to be, or is becoming, shareholder-oriented and is addressing, preferably aggressively, any short-term company issues or disappointments.
● The stock is so cheap that it could attract a catalyst for change, such as takeover offers or an activist investor who could force its board to implement management or business changes.
● The company's problems appear to be transitory, discrete or finite, and management has a well-conceived and feasible remedial game plan.
As noted above, if the majority of factors reflect these criteria, you should most likely hold or add.
Putting the above criteria into practice, let us revisit my recommendation from May 15, when I discussed Archer-Daniels Midland (ADM). The bottom line is that I still think ADM warrants a continued hold, and I recommend buying the shares amid the recent weakness.
ADM is lower now due to lower earnings, which were primarily caused by this summer's extensive U.S. drought and its very negative impact on the country's corn harvest. While this profit decline is disheartening, I am very comfortable in my belief that the weakness is transitory, and I believe earnings should start to show better trends two or three quarters out. Furthermore, I still think ADM is a dominant franchise with very favorable prospects. The stock is simply too cheap, selling at the absolute low end of its historic valuation range. Looking at the above checklist, ADM meets most of the criteria.
Next Tuesday, I will review my criteria for throwing in the towel on a laggard.