The rules of doubling down
Shares in RNY Property Trust have taken a dive since I bought them, down 25%. That does raise the question of whether I got the price right when I bought them, but that mistake, if it was one, is already made. The next question is, should I buy more?
Typically the advice goes ‘if you wouldn’t buy more shares today, you should probably sell them‘. Well that’s true, but it’s only partly true. Speaking for myself I think 2.4 cents is a great price, and I would find 2 cents per unit nearly irresistible. Even so, it’s necessary to consider the potential outcomes of the investment. There are really only 2 possibilities with RNY:
- I am right about the property values and I will make money
- I am wrong about the property values, and will lose money
There are shades of grey in there where the properties are worth more than the debt, but I make back less than I invested, for example, but this broadly sums up the investment. Either it’s worth more, or it’s worth close to zero. Let me say I would consider owning a portfolio of multiple companies in the same situation as RNY.
But in this specific situation if I were to buy more shares, I would be doubling my bet on a binary outcome without having any idea of whether I am correct.
That magnifies both the potential wins and the potential losses, but the drivers of the win or the loss have not changed. I think that on balance I have a good chance of winning. But if I was wrong in the first place, I am still wrong, and I don’t know it yet. I have not seen any additional information that would confirm or refute my initial thesis.
Let’s say that there’s a 30% chance that I’m wrong. Initially I’m risking 5% of my capital. Say I want to double down, making it 10% of my capital. Now imagine that someone said to you: “There is a 30% chance that you will lose 10% of your capital on this investment“.
‘Err, no thank you’, you stammer.
I don’t think a prudent investor would buy more in these circumstances. I would have to see more information, for example some more sale data and prices realized for the properties that would tend to either confirm or refute my thesis, before considering doubling up.
For another business that was earning cash and had the prospect of growing or paying that cash out to shareholders, I would be more likely to consider doubling down. I’d be highly likely to double down on Thorn Group Ltd (ASX: TGA) and Eureka Group Holdings Ltd (ASX: EGH) if they fell to 25% below my buy price. However, I don’t think it would be wise to do that with RNY.
Bronte Capital has a great post about when to average down which I think many readers facing a similar dilemma would find valuable.
Disclosure: I own shares in RNY Property Trust, Thorn Group, and Eureka Group.
For me deciding whether to average down becomes a question of high conviction. I am not all that comfortable with assigning odds to these sort of situations – it feels too contrived to me! Mind you, I am possibly doing the same thing in a different way – I am doing some sort of bayesian assessment of the situation and if I still hold a strong conviction the business is undervalued, then I will average down.
The one time I have averaged down strongly paid off very well, it was NWH and I chased them all the way down from around $1 to 20c – it is now trading at over $1.50 so a massive multibagger as a result.
Gday Rick, thanks for reading and apologies for the slow response. I try not to assign odds too specifically either. Usually with a stock I try to do something like “OK there’s a unlikely chance that X/Y/Z things will go wrong but in general the vast majority of outcomes are neutral or positive”. However, specifically in RNY’s case, the type of investment that it was meant that I needed to consider probability. It was liquidating, and X amount of debt and the properties were on paper worth more than the debt. So it was necessarily to evaluate “what are the chances of the property being worth more than the debt?” And also in those situation I try to take a ‘multiple situations’ view. For example it’s easy to fool yourself into thinking that you know the outcomes. So if I thought that RNY had a 60% chance of a positive outcome and I’d make 2x my money on it, is this an attractive risk-adjusted return? Even if I get unlucky and it goes to zero, is it still an attractive situation to invest in? What if I had 10 RNYs – do the gains on the 6 winners more than compensate for the losses on the 4 losers?
Like you say I think this is probably a poor approach for profitable businesses or those in turnaround, but if there’s a very real chance the company fails I think it is a useful tool. Congratulations on your NWH wins, by the way. That must have taken some conviction.