In last week’s blog post my colleague Hui Yi Tee talked about
common mistakes we can avoid when investing. Keeping broadly with
this theme, I thought I’d delve deeper into one of the pertinent
points she raised. This was the “sunk cost trap” – focusing on a
past investment you made instead of what that investment will look
like in the future.
We all like to talk about our investing “wins” – the stocks where we’ve made money and where the stock price has risen strongly since we first bought it/started buying it. It reinforces a positive feeling of being right while also making a profit. Mentally, that’s easy to indulge in. But what about when we make a loss?
Holding on too long
One of the best investors, Warren Buffett, is a big proponent of
the “buy-and-hold strategy” where you buy select stocks with the
ideal holding period of “forever”. Technically, this is the right
approach when buying stocks that are good businesses with solid
Yet situations can change and knowing when to “cut your losses” is just as important as identifying your next great long-term investment. What determines whether you sell out of a stock should not be daily gyrations in its price but whether the fundamental picture of the business that the company operates in has altered.
Buying and continuing to invest in a company which is seeing its business falter, and its share price see sustained falls, is a classic example of becoming ensnared in the “sunk cost trap” that was alluded to earlier.
Being disciplined is key so even if you have made a mistake investing in a company, it is equally important that you recognise this. Everyone who invests will have done this and I made such a mistake a few years ago.
My Lenovo story
In late 2013 I started investing in the Chinese Hong Kong-listed
Personal Computer (PC) and smartphone manufacturer Lenovo Group
(HSI: 0992). At the time, the company had a great track record of
producing top-notch PCs and was gaining market share in the global
PC market even as overall demand was shrinking.
However, what really got investors excited was its strong positioning in the Chinese smartphone market – a rapidly growing segment – where the company was number two to only Samsung Electronics (KRX: 005930) in terms of market share in 2013.
I was investing into the company monthly using Dollar Cost Averaging (DCA) for a period of probably around 18 months. However, this rosy outlook dramatically altered as a confluence of events conspired to turn sentiment upside down.
Firstly, even though for the whole of 2014 Lenovo continued to be in the top three in the smartphone market in China, its appeal among consumers began to wane as cheaper and more innovative homegrown brands, such as Xiaomi (HSI: 1810) and Oppo, ate into its market share. In 2015, it wasn’t even in the top six smartphone brands in China.
Secondly, it undertook two hugely risky acquisitions by buying IBM’s (NYSE: IBM) low-end server business for US$2.3 billion and Google’s (NASDAQ: GOOGL) Motorola phone brand for US$2.9 billion in the middle of 2014. This was done in an attempt to appeal to corporate clients and go global with its smartphone ambitions, respectively. These didn’t work out as planned and although the company had previously successfully turned around IBM’s PC business after it bought it in 2005, it found itself unable to repeat the magic nearly a decade later.
In the end, its share price reached a peak of HK$13.94 in May of 2015 and had fallen to about HK$5 a year later. I sold out of my holdings at HK$5.30, having incurred a loss of around 40% (investing via DCA helped bring this figure down), some time in 2016. Luckily for me it was a relatively small sum of money, which also indirectly highlights the benefits of diversification within a portfolio. Consequently, Lenovo is now currently trading around the same price (HK$4.81) as it was over two years ago.
What did I learn?
A few things. For me, personally, what I learnt first and foremost
was to focus on the longevity of a business and whether a company
has an investment “moat”. This means a business which has high
barriers to entry and is relatively insulated from competition.
Back when I was investing in the company, Lenovo had neither of these in the smartphone market. This was particularly true of the market in China during that period, which was a cutthroat business. Xiaomi and Oppo had released a wide array of smartphone options that left slow-to-respond competitors like Lenovo trailing.
Secondly, I realised that the hardware business in technology – think those companies involved in computers and particularly smartphones – is much more susceptible to being disrupted as compared to massive companies like Apple (NASDAQ: AAPL) or Samsung Electronics, with both having built up huge followings through their truly global offerings.
Software companies that sell its online services, such as a Google, Tencent (HSI: 0700) or Alibaba (NYSE: BABA), have much higher barriers to entry and are embedded in consumers’ everyday lives in the way that hardware companies may not be.
As Lenovo’s earnings continued to disappoint me, I lost confidence in the ability of Lenovo’s management to execute on its vision. The decision boiled down to whether I was willing to take a loss on the investment or to continue investing in Lenovo hoping for a turnaround. In the end though, what I chose to do was to put my money in other stocks. As I look back on this personal experience with Lenovo, one important lesson I learnt was the importance of making timely decisions on the viability of a business.
by Tim Phillips, English Editor @ FIGS
26 Oct 2018
(Please note that all views expressed in this article are solely my own and do not represent the opinions of FIGS or its related companies)
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