Should You Double Down on Winning Stocks?

2021-01-14     thesmartinvestor
Should You Double Down on Winning Stocks?

Sometimes you win, sometimes you lose.

It’s natural to have both winners and losers when it comes to investing.

As humans, we cannot expect to get it right all the time.

The idea is to accumulate more winning stocks than losing ones over time, such that on balance, we can earn a decent return on the capital we deploy.

Admittedly, it feels good when one of your stocks performs well.

But the hard part is in knowing if you should add more to the position, or if you should take some profit off the table.

It’s a happy problem to have.

However, if you have limited amounts of capital, it can present a problem. Should you accumulate more of a winning stock or spread out your bets to diversify your exposure?

Here are some factors to consider when deciding on whether you should double down on a winning position.

The secret sauce

First off, you need to understand what makes a stock a winner.

Is it due to a strong competitive moat that can fend off competitors, a unique product or service that is tough to replicate, or a customer base so loyal that others cannot make them switch over?

Whatever the reasons, the business needs this secret sauce to make it successful and help it to grow.

Some businesses rely on high switching costs and the network effect to help them stand apart from the competition.

For instance, Salesforce.com (NYSE: CRM) offers customer relationship management tools for businesses to better manage their client details.

Clients are “sticky” as it’s very tedious and time-consuming to shift to a competing platform when your systems and processes have been set up to integrate Salesforce’s suite of services.

Turning to social media, Facebook (NASDAQ: FB) is dominant because it has created a strong network effect.

As Facebook attracts more users, it makes its ecosystem more valuable to advertisers, thus creating a virtuous cycle that strengthens the company’s competitive edge.

Adding more capital to such winners makes sense only if you assess that they can continue to grow and that their competitive edge will not be eroded anytime soon.

A bright outlook?

Some businesses may also communicate an optimistic outlook because of tailwinds present in their respective industries.

For instance, Micro-Mechanics (Holdings) Ltd (SGX: 5DD), a designer and manufacturer of tools and parts in the semiconductor industry, has shared that the World Semiconductor Trade Statistics (WSTS) expects semiconductor sales to rise by 6.2% in 2021.

Top Glove Corporation Berhad (SGX: BVA), a manufacturer of nitrile gloves for the healthcare industry, reported a stellar set of earnings for its fiscal 2021 first quarter.

The company also estimates that global glove demand will grow by about 15% per year due to increased hygiene awareness caused by the pandemic.

Investors should feel use such data points to evaluate if it makes sense to add more to these winners as their outlook remains sanguine.

Thinking of alternatives

A third consideration is whether there are other, more attractive investment opportunities for you to park your money.

Thinking in terms of opportunity cost is useful in deciding where and how much capital to allocate.

While your winners may be doing well, the question is whether the capital can be deployed to a more attractive opportunity.

“Attractive” in this case refers to either a higher probability of rewards, a lower level of risk or both.

By contemplating alternatives, you will not end up only considering what you own, but can also take a more holistic look at other potentially great businesses too.

Get Smart: Be selective when adding

All in, the evidence points towards adding more to your winners.

However, it’s necessary for you to be selective when adding to these winners.

If the good performance was due to sentiment and is not supported by underlying business growth, then you should think twice about adding more.

In some cases, a strong stock surge could also be due to a one-off event that causes earnings to surge, but may not be sustainable in the long-run.

As an investor, you need to carefully work through each investment on a case-by-case basis.

Only then can you discern which stocks are suitable for adding more to.

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Disclaimer: Royston Yang owns shares in Facebook.

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