Conventional wisdom is frequently no wisdom. Investing, more than most endeavors, is larded with platitudes masquerading as profundity, such as: “Don’t throw good money after bad,” and a similar iteration, “Don’t catch a falling knife.”
Both clichés basically caution against investing in companies whose shares are falling (or have fallen). The corollary is to use a stop-loss order to limit capital loss at a predetermined percentage of your initial investment, say 10% or 15%.
I’ve never used a stop-loss. I’ve also frequently “thrown good money after bad” and have “caught falling knives.” Of course, I hold an opposite view. I’m glad to have “thrown” and to have “caught,” because I’ve picked up yield, lowered my cost basis, and amplified total return when I have.
I’m an income and value investor. I usually buy disfavored companies whose shares are trending lower. Sometimes I get it right, or close to right. I buy near the bottom.
Other times, I don’t get it right. The stock continues to fall, and sometimes not by an inconsequential amount. A few have even dropped an additional 50%. Did I panic? Did I self-immolate with regret? To the contrary, I continued to buy. In nearly every case, I’m glad I did.
Russian natural gas giant Gazprom OAO (OTC: OGZPY) is a recent example of my bucking conventional wisdom. I began to accumulate Gazprom shares after first recommending the company to Personal Wealth Advisor readers last year. At the time, Gazprom shares were trading at around $7.
I believed my analysis was rational. Gazprom shares were being pulled through the wringer on economic sanctions the West had imposed on Russia. A weak ruble and even weaker economic growth in Russia exacerbated matters. Russia’s desire to incorporate Crimea into the republic and its military skirmishes with Ukraine only added dead weight.
Where others saw despair, I saw value. Conflict and uncertainty frequently calibrate to produce value. I saw value in Gazprom. Its shares were trading at less than 3 times trailing 12-month earnings. Its shares yielded close to 6%. This is a company that sells over $90 billion of natural gas and oil annually. Value would be realized when political risk abated, so I reasoned.
Not everyone agreed with my assessment. Gazprom shares continued to fall, hitting a low of $3.60 in December. Nevertheless, I continued to recommend that Personal Wealth Advisor readers add to their position.
Never did I discuss a stop-loss. If I had recommended buying Gazprom with a 15% stop-loss, we would have been stopped out of Gazprom at around $6 a share. We’d have locked in a 15% loss. By recommending buying into a down trend, investors have been able to lower their cost basis and raise their yield.
Today, Gazprom shares trade around $6. To be sure, this is still below my initial recommendation price. But because I recommended buying more shares at a lower price, readers who followed my recommendation are in positive territory. My average cost per share is significantly below $7. My expected yield is above 6% (based on the last dividend).
My strategy isn’t for everyone. It requires patience and fortitude, which many investors lack. It requires liquidity, which you should keep anyway. As a rule, it’s always a good idea to have extra cash on hand. You never know when opportunity will arise.
You might push back and say, “Why not take the 15% loss and put the proceeds into a new investment that will rise?”
If life were only so tidy. In the real world, investors are just as likely to invest in another stock that drops 15% and stops them out again. You can stop-loss your way to zero. In my years of experience, I’ve concluded that stop-losses stop gains as much as they stop losses.
So, if I like an investment and I’m confident in my analysis, I’ll hang around. I’m usually glad I did. I’ll “throw falling knives” or “catch bad money,” or whatever it is I parroted at the beginning, as long it leads to positive investment returns. It frequently does.
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