If you invest long enough, you'll experience one of those days. A stock in your portfolio, one you researched long and hard, one that you've grown to love, gets absolutely hammered one day. I don't mean the 10% drops. I'm not talking 15%, or even 20%. I am talking about those days when the market just drops your stock like a hot rock on news that you never saw coming.
Usually it's a press release, sharing the news that sales won't be what management forecast so confidently just a couple of months before. Or maybe it's a new drug that was sure to be the next big growth driver for the company -- delayed, not approved, or with sales that disappoint. Or a one-time charge for something that had never even been discussed in a conference call -- an investment gone bad, some mysterious "one-time" charge that will just murder earnings, or some such. Sometimes it's information shared at the quarterly earnings call -- guidance for future revenue slashed, or news that a corporate partnership deal isn't panning out.
It can be an infinite number of things. And the result is panic selling -- and your stock is down 30%, or 40%, or even 50% in one day. What do you do?
Don't panic
The first piece of advice I have for you is the same as you'll hear in any stressful situation -- don't panic. Don't sell just because you see that you've lost a third of your money in four hours -- the market often makes snap judgments about new information -- selling first and asking questions later. Selling might be the absolute worst thing you can do.
Gather information
Try to get as much information as possible about the situation -- this is the first step. If the information that caused everybody else on the planet to sell your stock was released during a quarterly earnings call or press release, then by all means, read the release. Carefully. Listen to the conference call for clarification. How did the company managers communicate the information? Are they answering it in an informative way? Do you get the feeling they should have seen it coming? If the information was released as an earnings warning, without additional information, I again recommend carefully assessing the information. Often, these are the most frustrating cases, because there often isn't enough information presented to determine exactly what the long-term damage will be.
Re-assess the business in relation to the new stock price
This is the most important step. Before your stock imploded, you had a business that you (hopefully) understood well, and the stock was (hopefully) trading at a price that you felt was reasonable and allowed substantial room for appreciation. (If neither of these two conditions applied, you had no business holding the stock!)
Now, you have a business with some new information -- you must make the effort to incorporate the new situation into your assessment of the business. Is the recent event short-term in nature, or does it reflect a fundamental deterioration of the business?
Sometimes, the stocks of all companies in a similar industry or sector get hammered because of bad news that is not specific to your company. This "sympathy" effect can be hard to evaluate -- if your stock is down on bad news for the industry as a whole or on news of a competitor, you have to come to some conclusion about whether (and how much) that hurts your company's prospects. Often, these scenarios that aren't specific to your company are those where the biggest opportunities are presented.
Once you've reviewed the business and made your judgment on the effect of the new information to the value of that business, it's time to look at the new stock price. Was the sell-off an adequate reflection of the value lost by whatever development that took place, or is it an over-reaction?
Forget what you paid for the stock -- would you buy it at today's price?
Now we come to the hardest part -- forgetting what you originally paid for your shares. That's no longer relevant, but psychologically it's tough to get past. You have to, though -- otherwise, you cannot objectively evaluate the "new" stock idea; same stock, different circumstances, different price. You can be sure that there are many investors that make a lot of money by identifying stocks that the market has over-sold over short- term worries.
Pretend you are looking at the stock for the first time -- if you would buy it at today's price (if you didn't already own it), then you should hold on to your shares. If you would sell it at today's price, then go ahead and sell (at least you may get some tax losses to offset your gains). The toughest decision is whether to buy more. If the stock is now a tiny percentage of your portfolio and you are convinced that it's a great investment, go ahead and add to your position. If the stock (even after the haircut) still represents a large percentage of your portfolio, then it's probably a good idea to hold off adding to your position.
No matter what you do, remember this isn't an exact science. Take your time, be rational, and most of all, don't let your emotions get the best of you.
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Zeke Ashton writes for The Motley Fool Select and the Foolish 8 column. The Motley Fool has a disclosure policy.
