Lately, I received a question from a fellow subscriber of ours and it is as follows:
‘I have invested in a blue chip stock. Its stock price had fallen by more than 40%, resulting from an unprecedented event. Should I cut my losses or hold onto it?’
First, at Dividend Vault, it is our practise to not tell people what stocks to buy or hold or sell in the stock market. We want you to make independent decisions in investing matters and take full responsibilities on them, be it good or bad.
Here, in this write-up, I’ll expound on the key word ‘Blue Chip’ and share a little insights on my personal dealings with stocks that have capital losses.
1. The Origin of Blue Chip Stocks
I did a little research and discovered that the term ‘blue chip’ is used in poker. It is given the highest value among all coloured poker chips. Simply put, in a game of poker, people could place their bets based on the colour of their poker chips, where white chips are worth $1, red chips are worth $5, and the value of a blue chip is worth $25.
The term ‘blue chip stocks’ was first mentioned by Oliver Gingold, who was one of the earlier staff of a firm which would be known as Dow Jones in the 1920s.
At that time, Gingold noticed several stocks that were trading at above US$ 200 a share. He then told Lucien Hooper, who was with another brokerage firm that he intended to ‘write about these blue chip stocks’. Ever since, it has been used commonly to refer to higher-priced stocks.
2. Poker Players, we are not!
In a way, I believe that many had subconsciously associated stock investing with gambling as they likened stocks to be chips in a poker game, a hindrance to one who intends to build wealth sustainably in the stock market.
Instead, as investors, we view stocks genuinely as businesses, earning sales and profits from value-adding products and services from real customers. We invest to be co-owners of these businesses and believe that our wealth would grow as the businesses we invested into continue to grow over the long-term.
We are not poker players, trying to trade stocks for short-term profits.
We view ourselves as accumulators of great businesses.
3. My Stock Dropped by More Than 40%.
What should I do?
First, I believe what we really believe about stocks will influence how we invest. It is like a mirror that reflects upon ourselves. So, let us do an exercise together. For the ‘blue chip stock’ or any stock that you are in capital loss, ask yourself:
a. Why did you buy the stock?
b. Was your intention to invest, or to trade, or to speculate?
c. What kind of homework did you do to help you justify this stock purchase?
d. What was your intended holding period of this stock?
e. What were you expecting from the purchase of this stock?
Don’t make rash or emotional decisions. Take some time to reflect. It’s worth it.
4. What Kind of Portfolio Do You Want to Build?
This is about your next step, how you would envision your portfolio to be in the future.
For example, let’s say from above, you bought the stock to speculate and didn’t do much homework on it, before you made the purchase. You were hoping that the stock could rise higher in prices, but it fell by 40% from your purchase price. Then, you may want to decide the following:
a. Do you still want to continue to speculate stocks in the stock market?
b. Or, do you want to explore how others build their portfolios differently?
I cannot tell you what is best for your money. So here, I’ll share how I choose to build my stock portfolio and in an overly simplified manner, they are as follow:
a. I’m a dividend investor.
b. I invest primarily to earn incremental dividend income over the long-term.
c. I like to accumulate stocks of great businesses, especially overseas.
d. Great businesses = businesses that deliver consistent growth in profits.
e. Overseas = SG and HK markets (to store wealth in their currencies).
As a result, I built a portfolio that is filled with stocks that fulfilled the criterias.
5. Will You Buy Back the Same Stock at its Price Today?
Why is the above exercise important?
This is because it would determine what you will be doing with your stock.
For instance, if you want to continue to trade stocks, you may cut your losses as that could be a logical thing to do as a trader. If that is your route, then I believe it is important to see guidance from a stock trader, which I’m not.
As mentioned, I’m an accumulator of stocks of great businesses. Hence, I would assess the stock which is in a capital loss position on the following:
a. Business Model – Could it make recurring & scalable profits in the long run?
b. Financial Results – Its past 10-year track record on sales, profits & cash flows.
c. Financial Standing – Is it low in gearing ratio and does it have cash flow?
d. Future Plans – What are the stock’s initiatives to sustain its business growth?
e. Valuation Ratios – What is the P/E & P/B Ratio and Dividend Yields today?
Of which, I would ask:
a. Would I buy back the same stock at today’s price?
b. Are there any other stocks that would be a better deal than this stock?
If you come to this stage, you would have an answer to your question as to how or what you should do if your blue chip stock dropped by more than 40%.
Thanks for reading this. I hope you find it useful.
If you have any questions / feedback, please post them below at the comment section.