Monday, July 7, 2008

Cutting loss

Cutting loss is extremely painful thing to do. Not only it shows that you have made an error judgment on investing in a particular stock or fund, you also face the reality of losing your hard earn money by acknowledging this mistake. You will also face the dilemma to wait for “a few more days” to cut loss or to terminate your relationship with the loss-making investment immediately. There will be a number of “what ifs” resonating in your mind when you are contemplating to cut loss.

What if the stock rises after cutting loss? I already feel stupid for buying that stock at a lousy price. Now I feel even more stupid to sell the stock at a lousier price.

What if I don’t cut loss now and if falls further? Now I feel stupid not to sell earlier. Do I cut further losses immediately then or wait for recovery? Either way there is risk of feeling even more stupid if things do not go my way and I cut my loss anyway.


Is it possible NOT to feel this way?

YES!

Investors that face such dilemmas often only have an entry strategy (ie to buy stock) but no exit strategy (ie to sell for profit or cut loss).

One of the maxims in value investing is that you only exit when you make money. In value investing, you NEVER cut losses. You buy more when your stock drops. The rationale is simple from the illustration below.

Assume you believe Singpost is a value stock (like me).

It has long operating history, high profit margins, consistent dividend payout history and policy, high ROE and low debt. It is currently trading at below historical PE.

If you are willing to buy 10 lots of Singpost at $1.10, when Singpost dips 10% to $0.99, you should buy at least the same number of lots or even more. This is because for the same amount of price I spend on Singpost originally, I can now buy more with less money. I will collect more dividends with the same amount invested and at the same time, dollar cost average my investment.

Assuming I bought another 10 lots at $0.99, my average cost will be $1.045/lot. Singpost only need to rebound 5.6% from $0.99 to breakeven. It will take Singpost to rebound more than 11% from $0.99 for me to breakeven at $1.10.

You must believe in the companies you have initially invested in. Do not lose faith just because others have bought and sold it at a different price you had bought. The price changes all the time, not the fundamentals. Hence, do your homework thoroughly before you take the plunge and only invest in companies you believe in.

Then, you will never need to cut loss. You will be happy to buy more.

6 comments:

la papillion said...

Hi sgbluechips,

I don't think singpost has low debts.

In fy08, total debt to equity is 2.31. Perhaps it's due to the nature of the business (something like utility, i'm not sure since there's no good comparison for singpost) that it is highly leveraged. I say that because their Plant property equipment (PPE) stands at a substanstial 34.7% of total assets. They did sell off a lot of their properties already though, to be fair.

Current ratio stands at 0.90, not exactly wonderful either.

If it's not for the wonderful little monopoly (which is eroding with the liberisation of postal services) and the management's future direction of singpost AND the wonderful long history of good dividends, I'll be cutting loss on this one too :)

What do you think of singpost's pending sale of paya lebar HQ? At 850 million, it'll generate around $0.44 per share. Might give a bonanza of dividends for the divestment, when it occurs. Maybe 0.2-0.3 per share as special dividend?

Sgbluechip said...

Hi LP, thank you very much for sharing your views!!

The way I look at it, debts itself is a good tool to reduce tax and increase ROE for companies. Usually only conservative companies have low debt ratios. I think Allgreen is one of them.

Consider pp77 of Singpost latest annual report. It has borrowings of 302m, a tad lower than 2007's 316m.

Cash inflow for financing activities has increased 13m YOY, cash outflow from financing activities has been reduced by 8m.

Cash at bank has increased by 36m YOY.

I think the above shows good and improving financing discipline for Singpost.

For the special dividends, consider a worst case scenario:

Singpost gets 750m from the sale after some bargaining and pays up all its 300m debts.

It will still stand to gain 450m or $0.21 per share.

Again, we adjust 50% retention ratio, there is still a special dividend of $0.10 per share.

Singpost dividend policy is 80% payout ratio or $0.05 per share, whichever higher. Last year dividend rate was at 81% payout ratio.

Hence, it is definitely highly likely we can get a good bonus if the sale of the paya lebar HQ materialises.

Surprisingly the stock did not move up much this 2 days.

la papillion said...

Hi sgbluechips,

I think singpost doesn't move up so fast. There's a lot of fundhouse selling this, ever since they are kicked out of sti 'dragon tiger list'.

Hold and see loh :)

Sgbluechip said...

Haha, but still the company is almost idiot proof and integral part of any economy. Hence, it will remain a core component of my portfolio for recurring income.

jeflin said...

Singpost is a steady cash cow but there is strong resistance at the $1.24 level unless they substantially raise rates or buy back existing shares.

How are they coping with fuel costs will known soon.

Invest Money Lab said...

Personally, I do not think average down is a good strategy to go.

It is pretty high risk. What if the price keep falling further, we can incur higher loss that way.

Cutting loss early is a better strategy to help us minimizing our risk exposure. That's my view.