Recovering from losses incurred in a downturn
Downturns in the stock markets is not the time to panic, sell off and cash out. Rather, it is the time to bargain- hunt in preparation for the next upturn!
Benjamin Graham, the author of the book, The Intelligent Investor, and the inspiration behind legendary investor, Warren Buffet was perplexed by a pattern of behavior in some investors. They panic when stock market indexes touch a new high and begin to depreciate. The investors panic and sell out.
He explained that stock market indexes are benevolent. Once they reach a new high, they begin to depreciate due to profit taking; they often strive to (at a later time) touch the previous price highs on their way to another high. So he wondered why investors panicked. He advised them to be patient and hold forth their selling power.
Much has not changed today. In relation to the Nigeria Stock Market, investors witnessed a peak in the markets before the 2010 meltdown. Prices of stocks such as First Bank (FBNH) had an IPO (initial public offer) valued at N33.00. I am picking on the case of First Bank to make perfect illustrations on what an astute investor should do in time of distress.
First Bank sold at N33.00, IPO price. A year after, the stock had begun its slide down to the N3- N4.00 range after it issued a profit warning at the same time the market was in a melt-down.
If you had bought just 1000 units of first bank shares in 2007, it would have cost you N33, 000. True, dividends were paid but also came the profit warning that led to less dividends and a fall in price. By 2015, the shares of First Bank sold at N3.00. Meaning if you had another N33,000, you would have been able to purchase 11,000 unit of the stock at N3.00 per unit.
Now here is the argument. 1000 units of First Bank share purchased at N33, 000 plus another 11,000 unit of same stock at N3.00 gives you 12,000 units all now purchased at a cumulative price of N66,000. If we go by the law of average prices, we divide N66, 000, the cumulative sum paid for shares by 12,000 units accumulated. That gives us a price per share of N5.50k. In this case, just by buying at price lows with the same amount of money paid at price high, we have successfully accumulated more stocks (12,000 units of First Bank) at a much lower price of N 5.50k each.
What that means is that when market turns upwards and becomes bullish, just a small movement in prices upwards, we could have break- even at N5.5k as we see in this current bull market that has stretched the price increase to over N12.00. Meaning as soon as prices become just a kobo more than N5.50k, we are ‘in the money’ (profit) already.
Imagine we now bought a second 11,000 units at N3.00, the average price would have fallen even further than the N5.50k used in this illustration.
Therefore, downturns in the stock markets is not the time to panic, sell off and cash out. Rather, it is the time to bargain- hunt in preparation for the next upturn. You accumulate the lowered priced stocks at a bargain (once they are solid companies by analysis) and wait to ride the next market wave up.
Today, First Bank sells at N13.90 for Friday close. That is a profit of N10.90 from the low of N3.00 and N8.40 from a low of N5.50 used in the illustration. The opportunity still exists now because we are in a bull market and FBNH is still selling at discount.