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If you purchased the stocks in the table below a year ago you will be kicking yourself today. Share prices have been hammered by as much as 97% over the past year.

A $10,000 share investment in Babcock & Brown today stands at a measly $300 or so; a $10,000 investment in Fairfax languishes at $5,000, and a $10,000 holding in Fortescue Metals a year ago, now sits at just $2000.

Was buying these stocks a big mistake?

Company 1YR Return
 BABCOCK & BROWN (BNB)  -97%
 MACQUARIE GROUP (MQG)  -67%
 NATIONAL AUSTRALIA BANK (NAB)  -50%
 BHP BILLITON (BHP)  -45%
 RIO TINTO (RIO)  -51%
 FORTESCUE METALS (FMG)  -80%
 FAIRFAX (FXJ)  -53%

 

As a share investor you firstly have to come to terms with the fact that share prices don’t just go up from the day you purchase them. Share prices fluctuate in line with the buying and selling activities of other shareholders. And as the turmoil in international markets unfolds, it’s understandable that there’s plenty more selling than buying at the moment.

Most stocks trading on the Australian Securities Exchange (ASX) have dumped over recent weeks as investors sell shares to reduce debt, meet margin calls, or just to get the heck out of equities.

So if you own stock that’s currently languishing at lows what should you do?

You have the choice of hanging on, buying more or selling up.

The best way to make your choice is to ignore the share price for the time being (yes, I know it’s easier said than done), and focus on the underlying business.

Think of yourself as a venture capitalist examining a company for the first time. Does the company pique your interest? Does it sell a good or service that’s in high demand? Does the company have many competitors, and if so, is it a market leader? Does it have high or low operating costs? In short, do you back this company with your hard-earned cash to boost earnings over the long term?

Earnings growth is a major factor in determining stock prices. Companies with strong future earnings forecasts typically perform better than companies with lacklustre projections. Check out analysts’ yearly earnings forecasts for the stocks that you currently own (use forecasted growth figures rather than historical in these uncertain times, and note that many forecasts will be updated due to the change in market conditions).

It can’t be denied that the global credit crisis is a serious factor driving share prices right now. You must ask yourself this question: in a landscape of tightening credit conditions, plummeting consumer confidence and rising unemployment, how will your company fare?

Clearly, the industry that the company operates in will affect how it will cope in this new landscape.

Cyclical stocks are more likely to be badly impacted by softening economic conditions than defensive stocks. Companies that rely on borrowings will be worse affected than companies that are cashed up.

A good debt gauge is the debt/equity ratio, which compares a company’s total debt with shareholders equity. Basically, the higher the ratio, the higher the debt levels of the company.

In this environment, stocks with higher than average debt levels could be pummelled by the market so watch out (ABC Learning Centres is a good example of a stock that suffered at the hands of its shareholders from holding too much debt).

It could be said that smaller companies are less well-equipped to face economic and market turmoil than larger companies, so if your portfolio is heavily weighted towards smaller companies, then you might consider re-weighting it.

Also watch out for weakness in a stock’s industry group. If leading stocks in an industry fall sharply, it’s likely that other stocks in the group will follow the leader.

In sum, don’t view the share price as the determining factor for whether to hold or ditch that stock, but rather the quality of its business. Chances are, if the business is solid, the share price will rebound.

And if you strongly believe in the quality of the company, and all of its fundamentals stack up, then buying in now at a lower price could boost profits over the long term.

Top reasons to consider selling a stock

– Something has gone wrong with the company. It can no longer find new markets to sell, its costs have skyrocketed, there has been a deterioration of management, competitors have encroached on its market share and have driven down prices and so on.

– A decline in earnings or forecasted earnings with no logical reason.

– There has been a steady deceleration of sales.

– The reasons you bought the stock no longer hold true.

– The stock is too volatile for your nerves and you can’t sleep at night.

– There has been a change in management with a new direction – meaning the company you originally invested in has fundamentally changed.

– Profit downgrades and cuts to dividends is often a sign that the company is in trouble.

– Unfavourable tax rulings or legislation.

The good news

For those with an investment horizon of more than 5 years (and let’s face it, all share investors should be in this category), then the current market crash should be viewed like an end-of-year clearance sale. Stocks that you’ve previously wanted to buy – but always seemed a tad overpriced – are suddenly on sale at bargain-basement prices.

Each time you reinvest your dividends or top up your holdings, you’re buying shares at lower prices. If the share price is down by 30% from its highs, this simply means that you can buy more. When the market does rebound, your gains will be compounded.

Although it seems more sensible to trim or stop contributing money to your share portfolio or super fund when share prices dip, the opposite is true, if you’re in it for the long haul. There’s no point contributing at all time highs only to cut back when share prices come back.

In summary, unless you’re thinking of selling anytime soon (you need the funds for retirement or for personal living expenses) then a bear market could be viewed as a time to celebrate. Indeed, it could mean for a much larger pot for when prices pick up.