Holding for the long term may mean holding your position when other investors scramble out of the stock due to their limited time horizon. This is the current case for long-term investors in Natural Grocers by Vitamin Cottage (NGVC -3.94%) as the company's stock recently experienced an eye-catching 37% drop. The stock is now around 50% off its 52- week high, and this is likely even testing the mettle of seasoned long-term investors. Here are three tips to keep your resolve during a steep pullback in price:
1. Restate your investment thesis
Your investment thesis likely hinges on one of three investment types: value, growth, or income. It may also incorporate other factors such as confidence in a company's founder (i.e. Elon Musk) or a belief in a sector (i.e. 3D printing).
Your investment thesis can be as simple as: Natural Grocers is a family run public company that has the potential to rapidly expand in the next five years because of its small store size and its commitment to its five founding principles.
But however your investment thesis is comprised, it should be restated after a pullback price. This will ward off any impulse sells and bring you back to that once bullish mind-set.
2. Rationally evaluate what happened
Naturally when the market value of your investment is drastically below your cost, it is unnerving. But at no other time is it more important to be calculating and rationally evaluate what happened.
For Natural Grocers, the company revised its full year outlook for same store comparable sales growth from 8.5%-9.5% to 5.5%-6.5% and this caused a steep drop in price. Yet, this came on the heels of positive results for the first half of 2014 including a 8.1% same store comparable sales growth and a 24% increase in net sales.
Rationally evaluating price pullbacks can help you determine whether the drop in price was warranted or was an overreaction that may have created a buying opportunity.
If it is a buying opportunity, then your original investment thesis may still hold muster.
3. Challenge your investment thesis
You should challenge your investment thesis during a pullback because it was likely caused by a material change in the company's outlook—which should change your mind-set. Part of the investment thesis for Natural Grocers is the potential for expansion. To challenge this part of the thesis, start by looking at the competition.
In the organic foods market, Whole Foods Market (WFM) remains at the top. But there are several newer entrants, including Sprouts Farmers Market (SFM -2.41%) and The Fresh Market. So, can Natural Grocers rapidly expand in this competitive environment?
Natural Grocers sees impressive growth potential as outlined in its latest company overview:
The entire U.S. market can support at least 1,100 Natural Grocers stores, including approximately 225 additional stores in the 15 states in which we currently operate, or have signed leases, based on research by The Buxton Company.
Yet, Sprouts Farmers Market and Whole Foods also see similar long term potential as each estimate a potential United States store count of approximately 1,200.
Natural Grocers, however, does set itself apart in two ways in this deluge of competition. First, Natural Grocers has a "portable" store size that ranges from 5,000 to 16,000 square feet. This is considerably smaller than the 34,000 square feet on average for a new Whole Foods and might allow Natural Grocers a more scalable expansion.
Second, Natural Grocers is committed to its five founding principles which include quality products, affordable prices, nutrition education, community outreach, and great benefits for its associates. A commitment to high quality products was recently shown when it pulled all confinement dairy products from its shelves in April.
By comparison, Sprouts Farmers Market focuses on supplying its customers with the "opportunity to purchase healthy food at an affordable price."
Yet, these affordable prices at Sprouts Farmers Market are not benefiting its shareholders as its stock is around 50% off its 52-week high. And Whole Foods' stock also recently experienced a double-digit percentage decline after reporting last quarter.
If you own stock in any of these three companies, you are now faced with the decision of whether or not that company can achieve its long-term potential and challenging your investment thesis should help that decision.
Foolish conclusion
A steep drop price can test your resolve and cause you to rethink your original investment in a company. But remember, at one point you had a strong conviction in the potential of that company as an investment. I encourage you to use these three tips when other investors are scrambling toward the exit. And if your original investment thesis is still intact, then you may have saved yourself from selling at a loss and positioned yourself to realize future gains.
