Lessons From Investing in a Losing Stock

This article was last updated on May 4

Want to tell you a story about my trading history with Brocade Communications (BRCD). This was one the first stocks I bought when I started investing. It had just announced good results and was trading around $10.50, There were some good articles about it and I saw some positive news stories about it. The fundamentals looked good – solid financial ratios (PE, PEG, EPS growth), buy ratings from several analysts, no debt and it was in a duopolistic market – the only other major competitor was Cisco.

Yet a few months after buying the stock, it went down to $6.80, or down 35%! So why did the stock drop so much, even though I did my homework? Well here are some reasons I think why :

  • Shortly, after I bought the stock they settled on a SEC investigation for options backdating. Even though they paid a fine and had new management in place – this should have been a big red flag to me, and clearly meant I didn’t do enough research and review their Annual (10-K) or Quarterly reports (10-Q). It only takes one mistake for a company to lose it’s reputation but it takes a lot of time for a company to get it back. Institutions probably didn’t want to buy it until new management has a better track record.
  • Their biggest competitor is Cisco- CSCO (up 5% in the last 7 months). I should have realized that Cisco is a much bigger, better established company. It has better margins and was more diversified! It was as they sat best of breed in the sector and I possibly should have bought this stock instead. While I did do my research and that time felt BRCD had better relative growth prospects, I should have done the same analysis for their largest competitor.
  • Seasonal factors! Tech is normally weak during the summer. Brocade is a tech stock! I should have factored this in and waited to buy the stock. Similarly other stocks tend to have seasonal variations, like retailers fall in price at the start of year (Q1) in line with how they did over the holiday period when they generate most of their sales.
  • Before and after the positive earnings announcement (just before I bought the stock), the share price ran up about 30% – so I bought at the peak. I should have waited and had patience. Also another important lesson, buy low and sell high, which means never a good time to buy a stock when making all time highs.

Anyway, I am still holding the stock as I do believe in the long term it is a good company in a growth sectors (Networking and storage management). I am not selling anytime soon and hopefully their future earnings will improve. If the earnings and forecast are poor – I will probably sell and take the loss! However I will not forget the factors I should consider for my next investment.

Update – I eventually sold Brocade for a small profit a year or so after buying it. Two years after that it was bought out by a global player for $12.70. While not a huge gain from where I bought it, if I had held on for another year would have made 20% more! So my final lesson learned is that time is your friend and if you believe in a company then having a long term view can help you overcome the short term variations.

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