How do you know if a stock that has underperformed the market is still a good place to invest?
I wish we could invest in winning stocks all the time, but that just doesn’t happen because of the “unknown” factors. An unknown factor can be a tragedy from Mother Nature, impact from a shift in the global economy or an earnings miss, just to mention a few. The bottom line is that any unknown factor can be a negative surprise to a company, reflecting in a price decline. What an investor needs to look at is why they liked the stock in the beginning and what has changed, if anything, their conviction on the stock. Consider what led to the decline and determine how long will it take for the company to recover.
If the decline was caused from a one-time event, then perhaps you should hold on to the stock or add to your existing position at the undervalued price. As an example; back in 2009 Caterpillar missed their earnings and laid-off employees paying them a very nice severance package that hurt their profit. The stock declined from $40.00 to around $30.00 during that time and is now worth over $100 per share. Looking into the factor that caused the decline reiterated my conviction on the management of the company. The payoff was worth the wait.
If you don’t already own a stock that tumbled should you look at buying it in hopes that it can turnaround? What we don’t want to do is chase a stock hoping it will turn around and become profitable. If we “hope” then we should remain cautious because hope does not belong in one of the factors that increase a company’s earnings.
Look to see if management is buying back shares of the company. This is a good sign of the company being truly undervalued and growth may have stalled due to temporary issues. Look for a company that shows continued improvement in sales as this is a solid sign that a higher price may be ahead. Is the company investing into a new product? If so, how well have they done in the past with their products. Some companies can develop new products and implement into their strategy, such as Apple, where other companies cannot.
If the company rewards investors with a dividend, it may be worth buying to hold and collect the dividend while waiting for stock to appreciate.
Last, you don’t need to own at the beginning of a turnaround to make a profit.
Good Luck and know what you are invested in.