Watching the flood of corporate results today, I was reminded of a fantastic guide to effective investing I first read a couple of years ago. The Art of Execution by Lee Freeman-Shor (Harriman House, 2015) offers a simple manual for decisive, and profitable, investment decisions.
Anyone buying and selling their own shares should read this book. The bit that jumped out at me is its comparison of different responses to falling share prices, the point in the investing journey when so many of us stumble.
Freeman-Shor says there are three possible reactions to a failing investment. You can do nothing and hope that things improve. You can cut your losses and put your money to work elsewhere. Or you can add more to your holding, doubling down on your initial conviction.
He thinks that only two of these approaches make any sense. An effective investor will either sell their shares or buy more of them. Doing nothing is a recipe for failure.
I remembered the book as I looked at the share prices of two companies announcing results today, BAT and Foxtons. In both cases, the share prices have been disastrous in recent years. Many investors in both companies will have faced Freeman-Shor’s dilemma.
There have actually been plenty of other similar examples recently. Asos, the online fashion retailer, and Fever-Tree, the upmarket mixers maker, have also seen their shares fall sharply in the past few months. Investors in these companies, too, will have had to decide - fold, stick or twist.
So how do you make that very difficult decision? What are the things you should weigh up as you watch the value of your shareholding fall, 10, 20, 30% below the price you paid?
Here’s my short-list of suggested questions to ask yourself:
- What has changed since I bought the share? A good way of helping you answer this question, by the way, is to make a note at the time of purchase of why you are investing. If you can’t articulate the case for doing so clearly and succinctly, then maybe you are being told something. If nothing has changed except sentiment, then there is no reason why you should not add to your holding.
- Is there a fundamental reason why the shares might now be supported at the new level? In the case of BAT, for example, the company’s well-covered dividend now offers a yield of more than 7%. In the case of Foxtons, on the other hand, the dividend has just been passed.
- Is there any sign from the share price performance chart that the selling pressure is abating. Foxtons may not have BAT’s yield support, but the steep declines between 2015 and last summer have been replaced by a flat-lining share price over the past six months. Perhaps that signals a bottoming out of the decline.
- Am I holding this share to save face? One of the hardest things to do in investment, as in the rest of life too, is to admit that you got it wrong. We all do, of course. And to be a successful investor you simply need to get it right slightly more often than you get it wrong. If you are not buying more of a share after a 30% fall, challenge yourself. Why not?
- Have you fallen in love with an investment, perhaps because it has done well for you in the past? Don’t. It doesn’t love you and the past no longer exists. Make a judgement on the facts today.
If you are not already a shareholder in a company that has fallen a long way, your decision is rather easier. Unlike the investor sitting on a loss, you do not bring any emotional baggage to the decision. The psychological challenge you face in deciding whether or not to buy is nonetheless hard to manage effectively.
This challenge is known to behavioural psychologists as ‘representative bias’. It simply means that a share that has gone up tends to be viewed as ‘good’ while one that has fallen is ‘bad’. To go against the herd and buy the dog while avoiding jumping on the bandwagon of the winning share is very hard to do.
The true contrarian investor who can do this year-in-year-out is a rare beast. You have to really not care what people think about you. And we all do to a greater or lesser extent.
One of the best-known contrarians in the UK is Alastair Mundy at Investec. Among other funds, he runs the Temple Bar investment trust. Mundy talks about rummaging around in rubbish bins looking for the shares other investors don’t want. He is the ultimate bottom-fisher. It is a potentially highly-rewarding approach but very risky too. Sometimes, the conventional wisdom is right and you can look stupid for an extended period.
It’s worth remembering if you are thinking about bottom-fishing that if you buy a share that has fallen 80%, it only has to fall another 10% to wipe out half of your investment.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Reference to specific securities/funds should not be construed as a recommendation to buy or sell these securities/funds and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.