If you invest in stocks, then there's a good chance you're looking at some pretty hefty paper losses right now. After all, the S&P 500 is down roughly 20% in 2022, while the Nasdaq Composite has lost 30%, so scores of investors are feeling the burn.
The world is in a very different place than it was heading into 2022, and the companies behind the stocks you own may similarly be in very different places than they were when you first invested.
With extremely volatile market conditions and a worrisome economic outlook, should you sell a stock that has been crushed this year or try to ride out the storm? Well, it really depends on why you bought the stock in the first place. Let me explain.
Investment theses can change quickly
If you're investing in individual stocks, then you likely did (or should have done) a good amount of research into each business, including how the company makes money, specific drivers of revenue, what kind of economic conditions it performs well in, what might hurt the company, and numerous other factors. At the end of this research, it's common to develop an investment thesis that forms the basis of your decision to buy any particular stock.
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For instance, an investment in electric vehicle juggernaut Tesla (TSLA 4.82%) may revolve around a growing long-term market for electric cars tied to efforts to combat climate change, but their adoption so far is still relatively limited when you think about how large the vehicle industry is worldwide. So by investing in the largest and most well-known electric vehicle maker in the world now, you're getting in on the ground floor of what could be a once-in-a-lifetime opportunity.
But investment theses can change quickly along with the broader economy and market conditions, which have clearly shifted this year.
Few people expected inflation to be as high as it currently is, just as few people expected the Federal Reserve to be as aggressive as it has been with interest rate hikes or that Russia would actually invade Ukraine. Furthermore, the economic outlook for 2023 is pretty bleak with most people expecting some kind of recession in the next year.
Changing thesis vs. broken thesis
In light of these changes, your investment thesis has likely changed too. The question you need to ask yourself is whether the thesis has just changed but remains largely intact, or if it's completely broken. A changing thesis isn't necessarily a reason to sell a stock, while a broken thesis certainly could be, although there's no one-size-fits-all guideline.
For instance, going back to the Tesla example, imagine the U.S. National Highway Traffic Safety Administration, the agency responsible for vehicle recalls in the U.S., finds a big safety issue among all Tesla models and has to recall every single one of the company's vehicles on the road. This is of course entirely hypothetical and unlikely to happen, but that would be the kind of development that breaks a thesis.
But again, this is purely hypothetical. While Tesla stock is down 36% year to date, the company nearly reported a record profit in the third quarter. Furthermore, Tesla still expects to achieve its goal of 50% growth in annual production this year.
Now, could the valuation of the stock still be too high with a price-to-earnings multiple near 70? Definitely. And things have certainly changed for the company as Tesla is dealing with supply chain issues and may struggle to produce and sell as many vehicles as it hopes to if the economy slips into a major recession next year.
But is the broader thesis still intact? I would argue yes, because electric-vehicle market penetration has only reached 2% of U.S. households. More drivers will make the shift as charging infrastructure improves and climate change becomes a larger concern. The stock price may fall in the near term, but shareholders can still be confident it will rise long term and hold Tesla through the current market volatility.
Some stocks deserve to be sold and others don't
In a market where the large majority of stocks have seen significant declines due to high-level economic and geopolitical concerns, it can be hard to differentiate which stocks to hold and which ones to sell.
But the stock's decline itself should have little to do with your decision-making process if you're a long-term investor. If you believe the thesis has only evolved with existing market conditions, then look beyond the near-term losses, check your portfolio less often, and continue to hold the stock. But if your original thesis no longer holds, then you're indeed better off freeing up your cash to use elsewhere.
