Imagine that you are the happy owner of a stock, which you bought around $10 per share. You are convinced that the stock will rise to at least double what you paid, maybe more, in the near to intermediate term. Experts on CNBC are as impressed as you are about the stock’s potential, and the price has recently ticked up 20% to $12 per share. You thought it might, and you were right.
Suddenly, and unexpectedly, your stock falls to $11. This is temporary, you tell yourself, and you hold on. Unfortunately, the stock continues to drop over the course of a few weeks, and now sits at $7 per share, or 30% below your purchase price. The expert from CNBC who previously loved the stock? He has lately become less optimistic. A chart is displayed, showing that the price was around $2 a share only a few years ago, and you start to wonder if the stock will fall back to $2 again. It could. It might. Maybe it will!
What do you do? Buy more? Hold what you’ve got? Sell and take your losses? What if you hold and the stock falls further? You thought investing was about growth, but now you seem to be losing money, and it is no fun.
What can help you manage through, when fear grips the market?
For me personally, I gain a lot of comfort when I know there is a good and healthy business underlying the stock. You see, price is only one factor to consider. The other factor is value, and value has to do with the business that is represented by the shares. What are you buying when you buy a stock? You are buying a small piece of an actual business. As such, it helps to know and judge the prospects of the business, its balance sheet, etc.
If the business has a bright future, and assuming the shares are not priced too high relative to value, then there is no need to worry about occasional price dips.
(Our 2015 annual letter contained a similar essay, which served as inspiration for this piece.)