Learning What to Do When a Stock in Your Portfolio Underperforms is Key to a Successful Investment Strategy. Investing in the stock market comes with its highs and lows. As a buy-and-hold investor, you may find yourself holding a stock that underperforms your expectations. It’s a situation every investor will face at some point, and how you respond can make all the difference in your long-term success. This article will guide you through practical steps to handle an underperforming stock while maintaining a rational, disciplined investment approach.
What Does It Mean for a Stock to Underperform?
Underperformance occurs when a stock’s returns fall below your expectations, the performance of the overall market, or its industry peers. It’s essential to determine whether this underperformance is due to short-term volatility or signals a more significant issue with the company.
For example, during the COVID-19 pandemic, companies like Boeing (BA) underperformed due to industry-wide challenges in travel and aerospace. In contrast, some businesses see declines due to poor management decisions or fundamental weaknesses.
Understanding the nature of the underperformance is the first step in deciding your next move.
Steps to Take When a Stock Underperforms
1. Revisit Your Investment Thesis
Before making any decisions, ask yourself why you invested in the stock in the first place. Did you buy it because of strong fundamentals, growth potential, or a unique competitive advantage? If these reasons remain valid, short-term underperformance might not be a cause for alarm.
For example, Warren Buffett invested in Coca-Cola (KO) during periods when the stock wasn’t performing well, confident in its long-term value. This conviction paid off as Coca-Cola has consistently delivered returns over time.
2. Evaluate the Fundamentals
Analyzing a company’s fundamentals is critical when deciding whether to hold, sell, or buy more shares. Consider the following key metrics:
- Revenue and Earnings Growth: Is the company growing its sales and profits consistently?
- Profit Margins: Are the company’s margins stable or improving?
- Debt Levels: Does the company have manageable levels of debt relative to its cash flow?
- Valuation Metrics: Are the stock’s valuation ratios (like Price-to-Earnings or Price-to-Book) reasonable compared to its industry peers?
Example: During temporary market downturns, companies like Microsoft (MSFT) may see their stock prices dip. However, their strong fundamentals and dominant position in key industries like cloud computing and software often indicate resilience and long-term value.
If the fundamentals remain strong and align with your investment criteria, it might even be an opportunity to buy more shares.
3. Assess the Industry Context
Sometimes, underperformance isn’t a reflection of the company itself but rather a broader industry trend. For instance, energy companies often struggle when oil prices drop, even if their operations remain sound.
Understanding whether a stock’s struggles are company-specific or tied to its industry can help you make informed decisions.
How Wealthy Investors Approach Underperformance
Wealthy and seasoned investors view underperformance differently than most. Instead of reacting emotionally, they analyze the situation and determine whether the stock still meets their criteria. If it does, they often take advantage of the lower price to buy more shares.
Buying at a Discount
Think of underperforming stocks with solid fundamentals as being “on sale.” If you were willing to pay $100 for a share of a great company, wouldn’t you be even more excited to buy it at $80?
For example, during the 2008 financial crisis, many investors avoided buying stocks, fearing further declines. However, those who purchased shares of high-quality companies like Apple (AAPL) or Amazon (AMZN) saw significant gains in the years that followed.
When to Buy More
If a stock still meets your criteria and aligns with your long-term goals:
- Consider dollar-cost averaging to reduce your average purchase price.
- Use the opportunity to strengthen your position in a company you believe in.
When a Stock Underperforms: When to Hold and Monitor
Sometimes, the best course of action is to do nothing. Holding onto a stock while monitoring its performance allows you to make a more informed decision over time.
Patience is a cornerstone of the buy-and-hold strategy. Many great companies, like Tesla (TSLA), experienced periods of underperformance before delivering substantial returns. As long as the fundamentals remain intact, there’s no need to rush into selling or doubling down.
When to Sell a Stock
There are situations where selling is the right choice:
- The Fundamentals Have Deteriorated:
If the company’s financial health or competitive position weakens significantly, it may no longer be a good investment. - The Investment Thesis No Longer Holds:
For example, if you invested in a company expecting high growth in a specific market, but that market fails to materialize, it’s time to reassess. - Better Opportunities Exist:
If you identify another stock with stronger potential, reallocating your funds may make sense. - Avoid the Sunk Cost Fallacy:
Don’t hold onto a stock just because you’ve already invested in it. Past losses shouldn’t influence future decisions.
Behavioral Traps to Avoid
Emotional Investing
It’s natural to feel disappointed when a stock underperforms, but emotional reactions often lead to poor decisions.
FOMO (Fear of Missing Out)
Don’t buy or sell based on what others are doing. Always rely on your research and criteria.
Chasing Losses
Avoid the urge to “win back” your losses by doubling down on a stock without analyzing its potential objectively.
Proactive Risk Management
Underperformance is less daunting when you’ve diversified your portfolio and maintained realistic expectations.
- Diversification: Spreading your investments across different sectors and industries can help reduce the impact of any single stock underperforming.
- Set Clear Criteria: Define what makes a stock worth holding or selling, and stick to those rules.
Final Thoughts on When a Stock in Your Portfolio Underperforms
Dealing with underperforming stocks is an inevitable part of investing. By revisiting your investment thesis, evaluating fundamentals, and avoiding emotional traps, you can make rational decisions that support your long-term financial goals.
Wealthy investors recognize that temporary underperformance can be an opportunity, not a setback. By taking a disciplined approach, you can turn challenges into opportunities and continue building your portfolio with confidence.
Happy Investing!