The Motley Fool
MENU

2 Reasons Why Your Stocks Are Underperforming

Do you ever get frustrated with a stock holding, whose share price moves essentially sideways or worse, falls like a rock? Well, here are some logical explanations.

You bought it at an expensive valuation

Sometimes a business can be perfectly fine, but it could perform badly if an investor buys it at an expensive valuation.

Let’s use Canadian Apartment Properties REIT (TSX:CAR.UN) as an example. It is a residential real estate investment trust (REIT) with interests in multi-unit residential properties, including apartment buildings, townhouses, and land lease communities located in or near major urban centres across Canada.

The company is a quality REIT with a strong focus in Ontario, earning about 52% of its net operating income from there.

However, it trades at an expensive multiple of about 17.5, and it’s expected to grow roughly in pace with the long-term inflation rate of 3%. Its units can come down to its normal multiple of about 14.3 over time, probably triggered by bad news, such as rising interest rates or a Canadian housing bubble bursting.

Since the stock is priced at an expensive multiple, it’s likely to underperform, even though the business is doing fine. In the near term, its quality portfolio might allow the units to go sideways instead of downwards.

question-63916_640

Earnings deterioration

Occasionally, companies experience bumps and earn less profits than before.

For example, Empire Company Limited’s (TSX:EMP.A) earnings per share (EPS) for fiscal 2016 were 20% lower than the previous year. In the next fiscal year that ends in April, its EPS are expected to continue to fall.

The company has been facing challenges, particularly in western Canada, due partly to the Safeway banner. These challenges revolve around integrating, operating, and reorganizing the Safeway business, which Empire acquired in 2013.

For example, there were merchandising issues such as the private label conversion and supply chain issues, which impacted the offerings available to customers.

No wonder the shares of the food retailer have declined more than 30% from a year ago. Once management fixes the listed issues and wins back its customers, its earnings should improve and its shares should head higher.

Conclusion

Investors can aim to avoid buying stocks when they’re expensive by examining their valuations and their expected growth rates. On top of that, they can choose to sell stocks when the underlying companies are facing issues and cut losses if need be.

However, the best strategy is to identify great businesses and wait for opportunities to buy them at reasonable or discounted valuations. Then hold them for a long time. After all, even great businesses can experience bumps, but eventually, they will overcome the problems and hit new highs in the future.

The exclusive buy "signal" you can't ignore

Over the course of The Motley Fool U.S.'s 23-year history, this rare buy "signal" has generated massive wealth for those that have been smart enough to pay attention to it. It's so rare, that it's happened less than two dozen times ... but when it does ... it's made investors undoubtedly rich. If you're interested in knowing the stock behind this rare buy "signal"--and you're excited to take advantage of this golden opportunity, then you're going to want to read this. Click here to unlock all the details behind this new recommendation from Stock Advisor Canada.

Fool contributor Kay Ng has no position in any stocks mentioned.

NEW! This Stock Could Be Like Buying Amazon In 1997

For only the 5th time in over 14 years, Motley Fool co-founder David Gardner just issued a Buy Recommendation on this recent Canadian IPO.

Stock Advisor Canada’s Chief Investment Adviser, Iain Butler, also recommended this company back in March – and it’s already up a whopping 57%!

Enter your email address below to claim your copy of this brand new report, “Breakthrough IPO Receives Rare Endorsement.”

I consent to receiving information from The Motley Fool via email, direct mail, and occasional special offer phone calls. I understand I can unsubscribe from these updates at any time. Please read the Privacy Statement and Terms of Service for more information.