Over the past few decades, Warren Buffett has used many simple phrases that actually offer profound insights into the psychology of financial decision-making.
One that stands out to me is: “You don’t have to make it back the way you lost it.” Buffet called this “A prime rule of investing”.
The lesson behind this quote is to avoid the sunk-cost fallacy. In other words, resist the urge to hold onto a failing stock in the hope that it’ll rebound one day and break even.
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For example, if I buy a stock at £10 and it drops 80% to £2, it would then need to rise 400% to get back to the original price. However, stocks rarely rise 400% — and if they do, it takes many years.
Basically, the sunk-cost fallacy can lead to locking up capital in underperforming stocks instead of seizing better opportunities elsewhere.
My Diageo dilemma
I’ve been thinking about this quote while looking at Diageo (LSE: DGE), which owns timeless brands like Guinness, Johnnie Walker, Smirnoff, and Gordon’s gin.
Actually, Diageo’s a small holding in the investment portfolio of Berkshire Hathaway, Buffett’s holding company.
However, it’s a sizeable one for me, and a 41% drop in the share price since late 2021 means it’s been misfiring in my portfolio for some time now.
Spirits sector woes
To be fair, it’s not just Diageo. The whole global spirits industry’s in a slump, with inflation-weary drinkers trading down from premium liqueur. Most other alcohol stocks have struggled over the past three years.
This brings me back to Buffett’s quote above. Is this the right stock/sector to keep my money in? I mean, I doubled down earlier this year, and that position is also in the red. Overall, I’m down 17%.
Granted, there have been dividends along the way, as the FTSE 100 spirits giant has been pumping those out like clockwork for nearly three decades. The forward-looking yield now stands at 3.7%.
But the stock has never just been about dividends for me. I wanted a healthy bit of share price growth on top too.
Tariff headaches
The shares look good value to me, trading at 16 times next financial year’s forecast earnings. Then again, I thought they looked decent value a few months ago, and they’ve since fallen over 10%.
So, am I just blindly holding onto a failing stock in the hope that it’ll rebound one day? Am I falling prey to my very own sunk-cost fallacy here? It’s a possibility that’s been crossing my mind more often lately.
Looking ahead, Diageo also faces the risk of US tariffs on some of its best-selling brands. Donald Trump recently announced that he will “sign all necessary documents to charge Mexico and Canada a 25% tariff on all products coming into the United States“.
That’s not great for Diageo, as its number one brand in the US is Crown Royal Canadian whisky, while a key growth category there is tequila (imported from Mexico).
According to Deutsche Bank, Diageo could take an overall 8% hit to earnings per share (EPS) from Trump’s proposed tariffs (including any imposed on the EU/UK).
The firm is due to report H1 earnings in February. I’ll read that before making my decision. Time will tell if waiting is a mistake.
