About two years ago, my broker called me up to do a portfolio analysis. At the conclusion, he decided that I was doing well, but was concentrated in the area of Consumer Discretionary too much. (This makes sense since I look for companies with steady growth. Restaurants and retail stores, which are within the Consumer Discretionary sector, and that have a good product line and management team, can create steady earnings growth by just adding more locations. Other business areas cannot.) He suggested I add to my holdings in the energy sector, e.g., oil.
I was actually buying some oil stocks in another account. I was looking for a hedge against inflation (if inflation takes off, oil prices and other things you dig up out of the ground would probably increase in price as well), plus I wanted to diversify into more sectors, just as my broker was advising. I continued buying more shares in different types of companies linked to the oil boom. The ones I bought were Ensco Plc (ESV), Greenbriar (GBX), and Oasis Petroleum (OAS).
Of course as you probably know, this was right near the peak of the oil market. As oil prices fell into the twenties, all three of the stocks fell by at least 75%. Ensco went from $60 down to $8, Greenbriar went from $75 down to $22, and Oasis went from about $54 down to $4. Of those three, I sold completely out of one, cut one position back, and bought more of the third one. Here’s why:
I sold completely out of Oasis Petroleum. The reason isn’t that they lost more than 90% of their value. It is because their business had fundamentally changed. Oasis uses fracking to get oil out of hard-to-reach places in North Dakota. They were doing great when oil was more than $100 per barrel, but when oil prices dropped they were forced to shut down wells because it cost more for them to get oil out of the ground than they could sell it for on the markets. I also feel like the OPEC nations have learned that they need to keep oil prices below a certain mark – maybe $50 to $80 per barrel – or frackers will reopen and start to move the US towards oil independence. Without people buying oil from them, the OPEC nations have no other real industry to keep the rulers dressed in gold and pay for the lavish palaces, so they are not likely to make the same mistake again. Maybe they’ll let prices rise for a while, get all of the North Dakota wells running again, and then drop the price of oil again to cause a lot more people to lose their money and swear off the oil business. In any case, I don’t expect Oasis’ business model to be profitable anytime soon.
I cut back on shares of Ensco. Ensco rents deep-water drilling rigs used in the Gulf and elsewhere. As the oil prices dropped, so did demand for their rentals, but I expect that business to recover and be profitable again in the future, so I wanted to maintain some shares. I sold a few shares to take the loss to offset some gains I’d made, but still hold a position, waiting for the recovery. To simply sell out would have been “locking the barn doors after the horses had been stolen,” so to speak. There is room for recovery at some point in the future.
I actually bought more shares of Greenbriar. Greenbriar makes railcars, including tanker cars of a new design needed to meet regulatory requirements. Because their business extends beyond oil transportation, I expect the company to do just fine even with the lower oil prices. They’ll just sell more of other types of rail cars if oil prices remain low since lower oil prices will lead to higher economic activity, which means that more businesses will be shipping more things.
So when a stock drops, focus on the business rather than the stock price movements. Some of the best opportunities come right after a big drop. Also, if you add to the number of shares you have, you’ll be ahead when the stock recovers rather than just breaking even. Don’t expect to buy at the bottom, however – that is really difficult to do – but just know that you are getting more shares at a better price than you could in the past.
Sometimes, however, the business has changed and you just need to sell out and lick your wounds. Not every pick you make will pan out. You just need to know when to give up and go on, rather than waiting for a recovery that may never come. This does provide an opportunity, however, to cut back on some of your big winners that have grown to the point where it would be devastating to your portfolio if something were to happen. Maybe you’re thinking of selling, but don’t want to pay the large tax burden that would result if you did. You can deduct and losses you have against capital gains that you make, so it is a good tax strategy to pair losses with capital gains and reduce your risk if a stock has grown to become too large a portion of your portfolio.
Your investing questions are wanted. Please leave a comment and let me know what you think.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.