Ornoth

Today I won. I sold a stock for the same amount I originally paid for it, after having watched it lose 80% of its value. It took 4½ years, but I finally got out, and can happily proclaim that I didn’t lose a cent! What an emotional high!

The reason this is worth sharing with you is because it’s a “teaching moment”.

Virtually all smart investors would say I should have sold that stock earlier in its decline – even though it would have been at a loss – rather than hang onto it for years in hopes it would recover. And they’re absolutely right: I should have sold earlier. I was incredibly stupid, letting my vanity and loss aversion overrule my judgement, and I only escaped with my investment intact due to an unbelievable amount of good luck.

Let me walk you through the timeline of my investment, so I can explain exactly how stupid I was. Here’s the overview:

For 2½ years, Embraer looked like a viable investment, especially with the promise of a joint venture with Boeing. But then two “black swan” events crushed the stock: the Covid-19 pandemic, and Boeing’s drawn-out decision to unilaterally back out of the JV.

But as things headed south, I always had the opportunity to sell. I might have gotten out at a loss, but I could have invested those funds in a company that was growing, rather than continuing an epic collapse. Financially, it would have made lots more sense to take a smaller loss earlier and pivot quickly. After all, the Boeing deal wasn’t ever going to magically come back. And while I didn’t think the company deserved the $3.96 share price it hit at its lowest, there was no guarantee Embraer would survive Covid-19, much less fully recover and thrive.

There’s a sneaky but immensely important bit of math at work here that every investor should remember. My investment in Embraer had lost 79% of its value. But it takes far more than a 79% gain to get back to even. A 79% gain on $3.96 would only bring the stock price up to $7. In order to get back to my $18.50 purchase price, Embraer needed to gain another 367%! There aren’t many companies that can quadruple their share price, and even fewer investors who would be willing to sit around waiting for it to happen.

So the obvious question is why I didn’t get the hell out earlier? I think there are three reasons.

First, I hadn’t put a ton of money into Embraer, and as its unrealized value got smaller and smaller, the amount of skin I had in the game became less and less significant. When you’re already lost 80% of your investment, losing the remaining 20% isn’t that scary a prospect! Mentally, I had written off my stake in Embraer and just “let it ride”.

Also I didn’t think the company was so damaged that it justified a $4 share price. It had been worth $18 prior to the Boeing JV, and I was pretty confident that it would recover some (maybe most?) of its market value… if it survived the pandemic.

Those were the things I told myself, but the biggest reason why I never sold is because I didn’t want to be a loser. Selling an investment at a loss is an admission that I was wrong – that I made a bad decision – and “loss aversion” is one of the most basic emotional errors an investor can make. It’s probably the clearest example of how one’s ego can interfere with one’s ability to make rational investing decisions. And like any gambling “ploppy”, I was 100% committed to avoiding a loss.

In this instance, it’s hard to overexaggerate just how lucky I was. ERJ had to quadruple in value, without the Boeing joint venture, just for me to soothe my ego and get out without losing money, and it had to quadruple so quickly that I wouldn’t feel guilty about the opportunity cost of not moving that money to another company that would have grown faster.

I’d like to – and should – chalk that up as a painful lesson in loss aversion. On the other hand, I still might take the wrong message from this episode. After all, like a hard-luck gambler who hits a jackpot to climb out of a losing session, it’s hard to deny the emotional high that I’m feeling from my “victory” of finally getting out of my Embraer position without realizing a loss.

But I really should know better…

Last night I attended the Reel Paddling Film Festival at the Kendall, a three-hour collection of the best kayaking and canoeing films of the year.

On the way in, organizers asked attendees to register for two raffles. I didn’t bother registering for the national raffle, both because the odds are long and because I have no use whatsoever for a car rack. But I filled out an entry for the local raffle, since the prizes included a PFD, Teva footwear (ironically, I’d bought a pair just last week), and various passes to Charles River Kayak, the guys I rent boats from.

Over the years, I’ve developed a belief that rumpled raffle tickets have a much better chance of getting pulled from a hat than crisp, uniform tickets. So before I put my entry card in the box, I creased it both lengthwise and breadthwise, then creased each corner in opposing directions: forward, backward, forward, backward.

By now you should be able to guess where this is headed: when the intermission came around and the raffle was held, my ticket was the very first one pulled. Bingo!

Unfortunately, the first items they chose to raffle were Headsweats race caps, so I didn’t win any Tevas or boat rentals or the PFD. But as caps go, it’s a very nice one, since it’s made of the same CoolMax fabric used in most cyclingwear. In fact, it’d make a nice cycling hat, except that I’d have to cut back the brim, which was made extra long for paddlers of course.

With about 150 people in the audience, the odds of my winning weren’t astronomical, but it’s very interesting that after taking such care to differentiate my ticket from everyone else’s, my name was the first one chosen.