When a stock you own sees a price drop, it can be very good or very bad. Very good because it’s an opportunity to buy more, or very bad because you should sell.
The difference is in the impact of long term business results.
When a stock drops, a lot of the time it’s because something happened that was less favorable. Like with Apple many times in its past, disappointing iPhone sales can cause its stock to fall. But it’s not necessarily bad for the long term. If it’s a temporary hiccup, but Apple continues steady growth, then that looks like a chance to bargain buy.
But say people are straying away from Apple because Androids are now the “cool” phone. In that case, the demand is a symptom of lower revenues and earnings to come. That’s where it can be bad.
You can never tell with certainty which of the two cases it’d be for every (or any) company.
That’s why we need to differentiate from a numbers standpoint as well. Looking at both the numbers and the narrative is how to increase chances that we’ll be more right than wrong. The more you analyze stocks and the more you plug in numbers into a spreadsheet, the better you’ll get at making determinations like this.
And then of course, having the analysis done will give you the confidence and mindset to make the right decisions with your falling stocks.
Making the Right Investing Mindset Automatic
Try Googling a simple stock market phrase like “S&P 500.” Chances are, you’ll see two contradicting headlines, such as:
Which is it? As a beginner this can be daunting– and you just HAVE to know the real answer.
Well, compare it to when you first started driving. Routine things like merging onto fast freeway traffic was terrifying. Every move of the steering wheel, every placement of your hands, all laboriously thought out and fretted over.
Now I drive as second nature– as I’m sure all of you do too. But that overwhelming of the senses… all of the things you need to think about at once… it all takes up so much mental effort when you don’t have experience.
It’s the same with the markets.
And the media wants to feed off of that panic, that worry, to keep you addicted to their emotional (and not helpful) headlines and narratives. They’ll never actually teach you how to succeed in the stock market, because they know you’ll realize how silly their articles are.
Whereas when you have the knowledge and experience to understand that the market sometimes goes down… and that’s okay… you have a calm that keeps you from making stupid mistakes like selling too soon.
I received an email from eLetter subscriber and VTI client Joshua, who had some great perspective during a time of big stock drops:
“PS. i bet you been getting a lot of email about what to with the big correction/ crash today.. Its weird, but i feel as cool as a cucumber, while everyone else freaks out around me.”
That’s exactly right, cool as a cucumber. Instead of feeling sad about a smaller brokerage account balance, I’m indifferent. I know it’s going to change again tomorrow. And I know that what happens in one day isn’t going to make any difference especially because I’m holding for the long term anyway.
Taking Action (or Lack of) for Better Results
The key to finding success despite what happens with the stock price is to continue to hold for the long term. You have to trust that the businesses you own will do all of the work for you and continue to compound your capital.
You see, you don’t actually lose money when a stock drops… UNLESS you sell.
It’s really just a paper loss, and it has no reflection on the actual health of the business if the market is being irrational at that time.
What you have in the stock market is a huge swath of players trying to determine a stock’s value constantly. They all have different financial situations, goals, and motivations.
Add the obsession of short term price movements and day traders trying to capitalize on that from second-to-second, and it’s a wildly chaotic marketplace. Not a collection of rational buyers and sellers.
You have many investors and funds so focused on next quarter’s earnings release rather than a stock’s performance for the next 10 years.
The Bottom Line: The Right Mindset
I could go on and on… The bottom line is that there will be pockets of time where a stock could be much more expensive or much cheaper than the business is really worth.
It’s up to the individual investor like yourself to determine these cases and make your buying decisions off that.
When it comes to selling decisions, the mindset needs to be similar. Instead of focusing on the fact that you have falling stock prices, focus on what’s happening inside of the business through the financial statements (link for how to read an annual report).
Understand the difference between real business problems and stock market hype. Your portfolio will thank you.
There’s no reliable data that definitively says how to predict what any particular stock will do in the short term. There is plenty of data that shows that the stock market tends to go up by about 10% a year, and has done so for many decades.
If a business you own continues to do well, chances are it can achieve those 10% annual returns per year or greater. But to get those types of returns for your portfolio, you have to hold your stocks through adversity.
So shut off the constant feed of market reporting and chaos, and plug yourself in with valuable education on learning how to analyze great businesses. It’s likely to be a much more profitable endeavor.