03 Jun Recession Alert: What Should You Do When Your Stock Plunges Sharply?
Falling stock prices are part and parcel of being an investor.
While the economy chugs along fine most of the time, there are instances when a recession may be imminent.
Prime Minister Lee Hsien Loong has sounded an ominous warning recently about a potential recession hitting Singapore within the next two years.
We had established earlier that it’s not a wise move to sell all your stocks even when faced with the prospect of a downturn.
A question arises as to how you should react when one or a few of your stocks plunges sharply as pessimism builds up?
Should you buy more, hold on to the stock, or even consider selling it?
Assessing the reasons
First off, it’s important to realise that stocks fall for a wide variety of reasons: a failed business deal, poor earnings, lowered expectations, and weak sentiment.
The key is to discern the reason behind the stock’s decline so that you are better equipped to know what to do next.
Let’s take a look at several scenarios that help to explain why certain stocks had recently declined.
Adjusting your expectations
Many growth stocks listed on the NASDAQ have plunged sharply in the wake of higher interest rates as the US Federal Reserve is hiking rates aggressively to combat inflation.
Shopify (NYSE: SHOP) is one such example.
The e-commerce platform has seen its stock shrivel by 73.5% year to date, closing at US$361.53 recently.
However, its business is still demonstrating admirable growth rates, with revenue for the first quarter of fiscal 2022 (1Q2022) rising 22% year on year to US$1.2 billion.
Gross merchandise volume (GMV) has risen 16% year on year for 1Q2022 to US$43.2 billion.
The above numbers may look decent.
However, it pales in comparison to what the company reported a year ago when revenue more than doubled year on year to US$988.6 with GMV surging by 114% year on year to US$37.3 billion.
So, the “problem” here is not that Shopify has stopped growing.
Its growth has merely normalised back to pre-pandemic levels, and investors’ expectations have also come back down to earth.
In other words, it is the valuation of the company that has declined sharply, taking the share price along with it.
The business, however, continues to operate just fine.
Temporary or structural problems
One of the largest retailers in the US, Walmart (NYSE: WMT), also recently saw its share price fall 20% over three days to US$119.07.
The company’s 1Q2022 earnings saw net profit come in lower than expected higher costs ate into its bottom line, causing it to miss analysts’ projections.
To make things worse, Walmart’s updated its guidance to account for higher supply chain costs and inflationary pressures.
These events were responsible for the sharpest plunge in the retailer’s stock in 35 years.
Inflation, however, tends to be transitory and these problems should not persist.
Investors need to assess if a problem plaguing a company is temporary or structural to arrive at a rational decision as to whether to sell or retain a stock.
Weaker earnings and poor sentiment
We turn our attention now to former market darling iFAST Corporation Limited (SGX: AIY).
The fintech company had done well to capture heightened demand for investment solutions during the pandemic, with net inflows of S$3.16 billion and S$3.75 billion for 2020 and 2021, respectively.
These inflows pushed its assets under administration to a record high of S$19 billion as of 31 December 2021.
However, 1Q2022 saw the group report a sharp 35% year on year fall in net profit.
Along with it, iFAST’s share price has also more than halved from its all-time high.
Investors are also wary of its move to purchase a loss-making UK digital bank for S$73 million earlier this year.
This combination of poor sentiment and a disappointing set of numbers has depressed iFAST’s share price to its current level.
However, rather than focusing on just the bad news, investors may have missed out on iFAST’s eMPF deal in Hong Kong, which could multiply the group’s net profit seven-fold by 2025.
It may make sense to scoop up more shares to own for the long term if investors believe that iFAST can recover from these troubles to post better results.
Get Smart: Keep calm and analyse
The above examples provide some insights as to the causes of a stock’s decline.
Rather than panicking and selling your shares in a rush, it’s advisable to keep calm and analyse the situation.
Oftentimes, it could be a case of mismatched expectations and short-term worries that are causing the stock to fall.
Who knows?
Such events may even create great opportunities to accumulate shares on the cheap.
Disclaimer: Royston Yang owns shares of iFAST Corporation Limited.