Average down on losers

AVERAGE DOWN ON LOSERS

There’s a piece of val­ue-invest­ing folk­lore that goes like this: if you’ve done your home­work and the price drops after you buy, that’s a gift. Buy more. Low­er your aver­age cost. Dou­ble down on your con­vic­tion. The fun­da­men­tals haven’t changed.

At a cer­tain lev­el, sure, it makes sense.

But more often than not, we think it’s an ego trade dressed up as analy­sis.

Maybe if you’re War­ren Buf­fett or Char­lie Munger, and you’ve spent 500 hours read­ing every­thing there is to read about a busi­ness, its sec­tor, and its com­peti­tors, you’ve earned that lev­el of con­vic­tion.

But who has time for that?

The right ques­tion is nev­er “is this cheap­er than I paid?”

It’s “would I buy this today if I owned no shares?”

Those are very dif­fer­ent ques­tions. The first one is about defend­ing a deci­sion you already made. The sec­ond one is about whether the deci­sion still makes sense right now.

One of the rea­sons we use a sen­ti­ment chart (the 3PTL) to guide our invest­ing is that we accept we can nev­er know every­thing there is to know about a com­pa­ny and its short-term future. We rely on his­tor­i­cal finan­cials. But there are peo­ple out there who know far more about the busi­ness than we ever will — ana­lysts who cov­er the sec­tor, peo­ple who work in the com­pa­ny, its sup­pli­ers, its com­peti­tors. They have insights we can’t pos­si­bly match.

If the mar­ket is sell­ing a busi­ness down, maybe there’s a good rea­son. Maybe there isn’t. Either way, we’re not will­ing to bet our house on which it is.

So we err on the side of cau­tion. Even if our fun­da­men­tal analy­sis says the stock is under­val­ued, if sen­ti­ment has turned against it, we sit on our hands and wait for the trend to reverse. That’s true whether or not we already own it.

We have a few guards built into the sys­tem. The first is sen­ti­ment-based sell trig­gers, with a lay­er of “trou­ble at the mill” red flags on top. The sec­ond is the Josephine trig­ger (“not tonight, Josephine”) that stops us from buy­ing some­thing while we wait for the sen­ti­ment to turn around. And the third, above all, is Rule 1: a hard 20% stop. If a stock falls 20% from its peak, it’s gone. The losers don’t stay in the port­fo­lio long enough for aver­ag­ing down to even become a temp­ta­tion.

Because if a share price is head­ing in the wrong direc­tion, you have no idea how long it’s going to con­tin­ue. Months. Years. Maybe for­ev­er.

CSL is a stock a lot of peo­ple have been groan­ing about over the years. It had a great run, peaked just before COVID in Feb­ru­ary 2020 at $320, and then drift­ed between $320 and $248 for four years. In August 2024 it began a slide that has con­tin­ued to today, with the share price now south of $124.

There were plen­ty of peo­ple in the Aus­tralian invest­ing media plug­ging the hell out of CSL for the last six years. Buy the dip. Aver­age down. The fun­da­men­tals haven’t changed.

We thought it was over­val­ued at the time and stayed clear. We admire CSL as a busi­ness, of course. But it’s a text­book exam­ple of why you should­n’t keep buy­ing some­thing regard­less of val­u­a­tion and regard­less of sen­ti­ment.

You don’t need con­vic­tion in your picks. You need a sys­tem that does­n’t care if you have any. Put your con­vic­tion in your SYSTEM, not in your ego.

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QAV Myth Killers is a week­ly col­umn in the QAV newslet­ter, tak­ing apart a piece of
invest­ing con­ven­tion­al wis­dom. Read the series, or
get it by email every Fri­day.

Gen­er­al advice only. Space­craft Pub­lish­ing Pty Ltd
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