Wednesday, May 7, 2014

What To Do When Your Stock Plunges

Invest long enough and one morning you'll open your browser to check your stocks only to find that one of them is down 20% or more in pre-market trading.

Fortunately, this sinking feeling doesn't happen often, but shareholders in a number of popular stocks including Whole Foods, Groupon, and AOL certainly had a rough morning today.

At Clear Eyes Investing, we talk a lot about ignoring short-term market fluctuations and staying focused on the long-term. When a stock plunges in a single day, however, you do need to pay attention as the market is making adjustments to its longer-term assumptions about the company.

As Philip Fisher wrote in Common Stocks & Uncommon Profits:
Every significant price move of any individual common stock in relation to stocks as a whole occurs because of a changed appraisal of that stock by the financial community.
In other words, something important happened. It's time to do some research.

Once the stock has plunged in price, there's no point in wishing you'd sold earlier. The deed is done, but you do need to figure out if you should buy, sell, or hold based on the current opportunity.

Having been through a few of these myself, here are five guidelines that have helped me evaluate a stock that's just plunged:

  1. Take a deep breath and collect the facts. Read the company's press release and read the conference call transcript (if there is one). What's the market worried about? How is it different from what you assume in your model and thesis? 
  2. Avoid reading media reports. The media (both traditional and social) will sensationalize the storyline. The last thing you need at this point is another helping of emotion in your decision-making process. Focus on the facts. 
  3. What's management doing? Are they being honest and forthright about the challenges or setback they face, or are they trying to smooth things over with corporate-speak? What are they doing with their own money? I see it as a very positive sign if management uses its own money to buy shares in the company after a sharp share price drop, but only if it's a material amount. Picking up 100 shares of a $50 stock doesn't imply strong conviction. If management announces a more aggressive buyback strategy, that's also good, but I'd much rather see them using their own money.
  4. Re-evaluate your thesis and model. If your thesis is now kaput, it might be a good time to consider selling. Things could get worse. If you think the market has overreacted to the news, however, and your thesis is still largely intact, consider buying more. 
  5. Make a calm decision. If your heart is racing before you place a buy or sell order, go for a walk, listen to some Mozart, play a video game -- whatever calms you down and helps you make a firm and informed decision.
What tips do you have?

Stay patient, stay focused.


@toddwenning on Twitter