Stock Drawdowns Are Inevitable: Here’s How to Navigate Them
Insights from Mauboussin’s "Drawdowns and Recoveries"
Even God would get fired as an active investor. That’s the title of Wesley Gray’s paper, which imagines a portfolio built with perfect foresight. You’d think the results would be unassailable: buy Apple, Amazon, NVIDIA, and every other eventual winner, and you’re done.
Except not. Even this all-knowing portfolio would have gone through a 76% drawdown during the Great Depression, along with several other 20-50% crashes over the decades. Any fund manager running it would be left without a job long before the payoff.
That’s the paradox. The best stocks still go through gut-wrenching collapses. And human investors prone to psychological errors don’t get to stick around for the rebound.
Which brings us to the core problem: drawdowns are inevitable, but recoveries are not. The median stock never returns to its previous high, and that doesn’t even consider bankruptcies.
In today’s post, I look at Michael Mauboussin’s paper on drawdowns and recoveries in stocks and how it connects to Pim van Vliet’s work on low-risk investing.
Drawdowns and Recoveries
Stock drawdowns happen all the time. Whether cyclical, company-specific, or market-wide, they’re impossible to avoid.
That makes it essential to understand their frequency, causes, and consequences. Mauboussin calls them the “cost of doing business over the long haul,” echoing Charlie Munger: big drawdowns are the price of superior long-term returns.
Together with Dan Callahan, Mauboussin analyzed more than 6,500 companies from 1985 to 2024, measuring the magnitude of drawdowns, their duration, recovery from maximum drawdown, and the time to reach the previous high (if they ever did).
The median stock suffered a maximum drawdown of 85%. From peak to trough took about 2.5 years, and the recovery period was just as long. Crucially, the median recovery was only 90% of the prior peak, meaning most stocks never fully recovered.
The average results tell a slightly different story, thanks to skew. While the average drawdown was similar at 81%, the average recovery was much higher, driven by outliers like Amazon. The difference between median and average is crucial. Survivorship bias inflates the average, while the median never makes it back.
The deeper the drawdown, the longer the decline lasts, and the smaller the chance of recovery. Deeper drawdowns usually indicate more serious problems, like bankruptcy risk or fraud. A stock dropping 95% is the market telling you you are very wrong.
Mauboussin’s findings largely align with Van Vliet’s work: higher-risk stocks suffer larger drawdowns and are far less likely to recover.
The first rule of investing—don’t lose money—is easily broken when buying stocks in a deep drawdown.
Consider baskets of stocks sorted by drawdown severity. Starting two years before the trough, the large-drawdown basket collapses from 500 to 100 and never recovers, while the small-drawdown basket declines only 15% and compounds upward after the trough.
It’s the hare versus tortoise tale all over again: low-risk stocks win over the long run.
Still, drawdowns shouldn’t be ignored entirely. Occasionally, they produce spectacular returns—if you manage to time the bottom, or more realistically, accumulate on the way down, and if the stock actually rebounds.
Mauboussin’s research shows that when measured from the trough, the CAGR in total shareholder return over the five and ten years following the trough is roughly twice as high for the largest drawdown basket compared with the smallest.
This collides with Van Vliet’s momentum requirement. He suggests focusing on stocks with positive momentum, while stocks following a larger drawdown outperform.
The key takeaway is simple: generally focus on low-risk, slow and steady stocks, while preferably buying during a drawdown. Deep drawdown stocks can deliver extraordinary returns, but only if the risk/reward is clearly in your favor. You need conviction, a strong gut, and experience navigating the psychological challenges of the market.
It’s equally important to understand what type of drawdown the stock is in. Context matters. Mauboussin highlights the factors investors should look at before trying to catch a rebound.
What To Look For at the Bottom
The bottom can be lonely. Buying into a deep drawdown is like being stuck at the bottom of a well. It’s dark, lonely, and the longer you sit there, the more you doubt a way out even exists.
That’s why rational analysis is critical when buying drawdown stocks. Look at the facts.
Are the Fundamental Issues Cyclical or Secular?
Ask yourself if there’s reason to believe demand will rebound. If the issues are secular and lasting, you should probably exit. Nothing will change.
Mauboussin compares Nvidia’s drawdown (which ultimately recovered) to Foot Locker (which didn’t):
“NVIDIA declined along with other stocks in its industry whereas Foot Locker dropped at a time when the stocks of a lot of retail companies rose. For example, the shares of Walmart, the largest retailer in the U.S., had a TSR of more than 400% over the period of Foot Locker’s dramatic drawdown.”
If cyclical, the drawdown may simply reflect a temporary ebb. Growth should return.
Markets are forward-looking, and sometimes the drawdown reflects expectations rather than current fundamentals. Take Adobe, for example. The company isn’t in secular decline, but investors fear Gen-AI could erode its moat, and the stock trades as if that threat is already here.
This forward-looking punishment complicates the cyclical vs. secular question. Drawdowns don’t always reflect today’s fundamentals; often they reflect anxiety about the future. As Mauboussin notes, “This point is intuitive and is much easier to assess after the fact than in real time.”
Ah, if only we had all-knowing foresight.
What Does the Basic Unit of Analysis Tell You About the Business?
How does the company actually make money? If the business creates real value, recovery is possible. If it doesn’t, the chances of recovery are slim.
Consider the value stick. Customers need to feel they’re getting a surplus, suppliers must capture fair economics, and the company itself has to keep a healthy share. When that balance exists, a business under pressure can slow down, reset, and climb back.
Adobe’s economic proposition generates significant value. Its subscription model drives strong customer lifetime value, and the unit economics per customer are robust.
At the same time, it creates consumer surplus by offering industry-standard, feature-rich tools integrated into a single, connected ecosystem. In practical terms, Adobe enables customers to create things that would otherwise be impossible or prohibitively expensive in time, skill, or cost.
How Lumpy Are the Investments in the Business?
Large versus small investments matter because it’s easier to scale down small investments. When TSMC builds a $20 billion factory and the industry declines, it can’t simply scale back.
In a drawdown, business investing in small increments are preferable. Adobe fits this perfectly. Its investments aren’t tied to huge projects. Expanding capacity or rolling out new features, like Firefly, doesn’t require massive upfront costs because the company already has the customers and the distribution.
Is There Sufficient Financial Strength?
This one is relatively straightforward. If a stock is in a deep drawdown due to a poor balance sheet or large losses, stay away. Adobe’s balance sheet is healthy.
Is There Access to Capital If Needed?
Again, quite straightforward. During market distress, access to external capital becomes harder. The company must be able to raise funds if necessary.
Is Management Clear-Eyed about the Challenges?
Ultimately, businesses are people. You need management that is honest and communicative, especially in a drawdown. Do they acknowledge fundamental problems or blame external factors?
Adobe isn’t facing fundamental issues but risks obsolescence. Management has been proactive in the Gen-AI space, introducing and distributing its own AI products and even integrating many third-party solutions. They are clearly responding to change.
Navigating Drawdowns Requires Discipline and Context
Drawdowns are unavoidable. Even the best stocks experience them, and even an all-knowing investor would go through the pain. The reality is that most stocks never recover, and if they do, most investors rarely hold long enough to see it.
The takeaway is to focus on low-risk stocks to minimize the chance of losing money. That doesn’t mean avoiding drawdowns entirely—again, they’re inevitable. When you do consider buying into a drawdown, context is everything. Ask the key questions outlined earlier.
Stocks like Adobe illustrate what to look for: strong economics, small incremental investments, a healthy balance sheet, and management actively adapting to change. In these cases, drawdowns can be an opportunity.
Thanks so much for reading.
Lucas
Author & Founder, Summit Stocks
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Disclaimer: the information provided is for informational purposes only and should not be considered as financial advice. I am not a financial advisor, and nothing on this platform should be construed as personalized financial advice. All investment decisions should be made based on your own research.
Great article! One of the best insights I have read in a while!