Question of the Day: If You Own a Stock that Drops 50%, How Much Does It Have To Increase To Get Back To Even?
Math alert! This is an interesting way to show students one of the most important tenets of investing which I might summarize in an informal way as “Avoid Disasters.” What are disasters? Well, it might be my initial foray into investing in 1989. I bought a stock called CheckRobot (it pains me to even type these words). A revolutionary company to bring self checkout to supermarkets. Labor savings, great ROI, a management team. All the ingredients for a phenomenal investment, right? Let’s just say I was a little early. A year later the stock was down 83% and the pain of opening my brokerage statement every month (pre-Internet days so no online access) eventually led to a sale and an important lesson learned. And no, the stock price never did recover.
Sorry for the digression. Back to the example. Most students will have a gut reaction that if a stock price falls 50%, well it has to increase 50% and then you will be back to even. Aha, a learning opportunity! Take an example:
- You purchase SureThing Labs at $10/share
- It drops 50% (stock price is cut in half) and now the share price is at $5/share
- How much will the stock price need to increase to get from $5 back to $10/share?
Voila, the stock price would need to double (or a 100% increase), which is quite a large hill to climb. How to put this lesson to work. Avoid Big Disasters (like CheckRobot) and instead diversify your portfolio by holding a variety of assets.
About the Author
Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.