Why Law of Average does not work at all times?

We always tend not to book loses on any investment even if the investment has eroded our substantial capital and even if the company is no longer an attractive investment. We always tend to average out on falls in order to find an opportunity to exit out of the stock without any loses.

Is averaging stock price always good enough?

Today we will talk about two big US financial firms which have been a star performer for more than 2 decades now, Fannie Mae and Freddie Mac and the fate of top investment firm holding positions on to this securities.

Big investors in Fannie Mae and Freddie Mac face a brutal Monday. Shares in the mortgage giants, which have already lost 90% of their value over the past year, are likely to plunge anew in the wake of the government's announcement Sunday that it is taking control of the companies and ending the payment of common and preferred dividends.

Given that both Fannie and Freddie have posted billions of dollars in losses during the past year, and that billions more are expected while house prices continue their historic decline, it's not likely that the market will accord much value to shares that give holders no right to select board members or otherwise oversee management.

Bill Miller, the Legg Mason mutual fund manager, was Freddie Mac's largest shareholder as of July 31, with 12% of the company's stock.

The government intervention comes just over a month after Legg Mason's Miller reported a sizeable purchase of Freddie shares. Miller came to fame with a 15-year run of beating the S&P 500. But that streak ended in 2006, and since then his Legg Mason Value Trust has lagged far behind the market.

Miller's run of poor results hasn't made him any less aggressive, however. He has owned Freddie shares for some time but has been doubling down on the company as its shares plunged over the past year. Legg Mason owned 15 million shares at the end of 2007, when Freddie stock was fetching $34 a share in the market. He then boosted that figure to 50 million in the first quarter, as shares dropped into the teens in the wake of the collapse of Bear Stearns, and 80 million at July 31, when the price was below $10.

Freddie Mac and Fannie Mae shares at the time of writing this article is trading at around 1$ each. The fate of investors who have taken position couple of months back when it was trading at around $40 is unknown at this point in time. If this is a case with a multi billion dollar firm think of Indian investors who try to average out positions in small and mid cap stocks. Investors should always experiment caution and do a detailed analysis on the prospects of the company growth before re-investing in the stock at lower levels. It is always good to investigate the reason for the fall in stock price before adding on the shares to the existing portfolio.

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