MARKET COMMENT
The Truth About Paper Losses

By Maynard Paton (TMFMayn)
December 12, 2003

Anybody buying shares over the last few years will be familiar with the term 'paper losses'. But are such losses anything to worry about? Some investors say 'a paper loss is still a loss'. Others would argue 'you never make a loss until you sell'. The truth of the matter lies somewhere in between.

To understand paper losses, you have to recognise the value of any share is based on the underlying company's potential. The trick then is to find businesses with good prospects, but which the market has overlooked. Say share X trades at 100p; you consider it to be worth 150p based on various factors (e.g. potential earnings growth, valuable assets, generous dividend etc.), so you buy in.

But it's a lucky investor who never sees his shares decline after purchase. If share X falls to 80p to produce a paper loss, have you lost money? Not really, assuming the investment story remains intact and the shares are still 'worth' 150p. You hold tight, wait patiently for the market to cotton on and forget all about the 'loss'.

However, companies do change for the worse. That profit growth may evaporate, the talented boss may retire, and so on. One good example of a business going bad is Baltimore Technologies (LSE: BLM). Anybody buying shares of the Internet security firm during the heady £135 days is currently down 99.9%. With Baltimore having sold off its operations to become a cash shell, there's no way it's worth what most people originally paid. Paper losses here are indisputable losses.

What to do with paper losses now? Simply reassess why you bought the shares in the first place. If the reasons still stand and the shares remain undervalued, then you'll only record a loss if you choose to sell. But if the company has deteriorated and/or the value has all but gone, then don't delude yourself about a paper loss not being a genuine loss.

More: When You Should Sell Shares

This article was first published in February 2003.