Is it possible to mistakenly invest in the wrong company?
Even after a due-diligent analysis and study, it is not safe to assume that all our investments are foolproof.
Investing itself is still a game of risk and reward. At the time of finishing analyzing and putting our money into a stock, chances are the reward outweighs the risks. But as the future and truth slowly unfold, we might find ourselves making a wrong decision.
So, what to do if that happens?
Is the Company In the Wrong Business?
Investing in a company is buying into a company’s growth and prospects. The basic belief in investing is believing a company’s share price will move up in tandem of its growth and prospects.
Conversely, a company in a sunset industry or declining business segment would see its share price fall lower and lower.
We live in a world where things are evolving rapidly. Today’s bull thesis of a company could be obsolete if the company does not innovate and improve. But to reassure you all, Rome was not built in one day, nor did it fell in one day either.
Keep track of your investments at least on an annual basis. Re-review your thesis and if things turned out the opposite, we need to make tough decisions to limit the losses.
Is The Company Erratic and Unpredictable?
There are companies that are in the business where they share relatively more systemic risks.
Systemic risks are risks that comes together with the company that cannot be nullified or reduced. Some very good examples of companies who tend to have relatively higher risks due to the unpredictability are commodity companies.
We can hire the best managers, the best CFOs and even the best CEO to run a commodity company. But during periods of tough time where the commodity prices work against a commodity company, this company would still succumb to loses.
Some companies might not be in commodities but rely heavily on commodities like airlines relying on jet fuel. Airlines also have a systemic risk on any pandemic related incidents that would occur again.
Is The Management Acting in the best interests of Shareholders?
As investors we see ourselves buying into a business and becoming a sleeping owner. The everyday operations and management of a company rest heavily on the shoulders of the Management team.
So it is of key paramount that the management has the motivation and capabilities to grow the company’s business.
But sometimes, company management might put their interests above the other shareholders’ interests. Some company executives who are the substantial shareholders might make shady related party transactions for their personal benefits. This not only erodes the company’s prospects but could also severely impact the company share prices as well.
If any of the symptoms from the above are present, it could be hinting that we might be investing in the wrong company.
Sometimes the best investment decisions are not made by holding onto great companies. Rather, it is also knowing when to mitigate further losses from an underperforming stake in a problematic company.
Even though not cutting loses on a losing company theoretically means you are not losing money, but the losses might continue to escalate. Never losing money is not about being stubborn about realizing a loss. But rather it is for us to nip the loses in the bud rather than letting it blossom.
Holding onto great investments and being patient is one side of the coin for being an investor. Knowing when to limit a loss and to stay away from problematic companies, is the other side.
And knowing when to cut losses on an underperforming company is what differentiates the good from the best.
What are your key cut losses that you think benefited your investments the most? Let us know in the comments!