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They Don't All Go Up
...At least not right away. Unfortunately, not every stock we recommend (or buy in our personal accounts) immediately goes up. We thought it was worth sharing our thoughts on what to do when a stock you’ve bought goes down.
There is an old adage among investors that you should “Sell your losers and let your winners run.” We don’t disagree with letting winners run--subject to the caveat in the next paragraph--but we would advise against a knee-jerk sale of any stock that is down. This is especially true in dealing with turnarounds or other deep value situations. Because turnarounds often take longer than you expect, patience is especially important in this type of investing. It is important to have a longer-term view even though most other investors may be focused on short-term results. Few things are more frustrating than selling a stock just before it finally turns the corner and takes off.
The key to making good decisions about underwater stocks (as well as stocks with gains) is to evaluate the future prospects of each stock based on all that you know about the company at this moment in time. Investors must consider their own tolerance levels when it comes to both potential future losses and upside if, indeed, the turnaround is successful.
You need to figure out what is the risk and what is the reward potential in each stock right now. As hard as it may be to do, you should ignore what you paid for the stock. You can’t get the purchase price back--instead you have to figure out where the stock is going from here. (The only time the purchase price is relevant is when you are doing tax planning, at which point you need to think about taxable gains and losses.)
For example, take a stock trading at 10. Investors who bought it at 20 probably think it is a terrible stock to own while investors who paid 6 for it may love it. The key question is “Where is it going from here?” If it is likely to go to 16--a 60% gain from where it is now--you should hold it or even buy more regardless of what you paid for it in the past. Conversely, if the current information suggests that the stock will drop to 8, you probably should sell it.