JANUARY 14, 2007
When Buying a Stock, Plan Your Goodbye
By ANJALI CORDEIRO
Added a new stock to your portfolio? It's time to think about selling.
No, we don't mean you should unload that promising new holding tomorrow. But what you should do, before any more time goes by, is think carefully about when you might sell down the road.
Choosing when to let go of a stock can be tricky.
- Investors are often reluctant to admit they were wrong and tempted to hang on to losers in the hope of a turnaround.
- Judging when a winning stock has peaked can be just as perplexing.
A well-thought-out game plan for when to sell raises the odds that your decision will be rational rather than emotional. That may help maximize your returns.
"The sell decision is the most important decision you can make" in investing, says Barry James, president of James Advantage Funds in Xenia, Ohio. "Even if you buy randomly and have a good sell discipline, you can probably outperform the market over a period of time."
Here's a look at a few selling strategies professionals rely on.
Sell When Profits Deteriorate
A sharp earnings disappointment can be a good signal to sell because it is often followed by more bad news, says David Kovacs, a senior portfolio manager at Turner Investment Partners in Berwyn, Pa. "It's easier to sell and move on to another idea, rather than holding on to the stock and seeing potentially significant further declines," he says.
In 2004, he and other holders saw shares of eBay (EBAY) soar from $32 to around $58 by year end. But in January 2005, the stock plunged to almost $40 on a weak financial forecast, and that's about when Mr. Kovacs's firm sold. The stock tumbled further, back into the low 30s, over the next three months. (These prices are adjusted to reflect a 2005 stock split.)
"When the first chunk of bad news comes out, don't just sit there," concurs Daniel Morgan, portfolio manager at Synovus Investment Advisors in Atlanta. This can be particularly applicable to smaller, fast-growing companies that trade largely on expectations of future growth.
Still, Mr. Morgan cautions investors to sell only if the news reflects a fundamental shift in the business. Remarks from television pundits or analysts are usually bad reasons to sell a stock, he says.
Pick a Price Target
Vince Gallagher, co-portfolio manager of Needham Growth Fund in New York, says that when his fund buys a stock, the managers usually have a target sale price based on the earnings outlook and the potential for the company to grow its business.
For instance, they bought disk-drive company Seagate Technology (STX) at around $12 a share when it went public at the end of 2002. The team decided to reconsider their position when the stock got to about $25, because they felt at that price the stock would be trading at a hefty multiple to expected future earnings. In late 2003 the stock crossed $25, and the fund did sell some of its shares, but not all.
In hindsight, Mr. Gallagher wishes the fund had sold more, because the stock started falling soon after. "You can get carried away with a stock when it does well," he notes. "The lesson we've learned is that you should have a target when you buy a stock, and you should stick to the target."
Mr. Gallagher does, however, suggest investors rethink their price target if there is a big change in earnings or sales.
Monitor Reality vs. Rationale
Investors need to be very clear on why they bought a stock; they should review their rationale periodically and should also rethink the position when the reason no longer holds, says Craig Hodges, co-portfolio manager of the Hodges Fund in Dallas.
In simple terms, he says: "If the story changes [for the worse], get out of the stock."
About four years ago, his fund bought XM Satellite Radio (XMSR) at around $3 a share. Mr. Hodges initially thought the stock was worth $15 to $16, but raised his target as he saw XM wasn't just signing up individuals, but was also brokering deals with car companies. He figured the subscriber growth would eventually lead the company to profitability.
Mr. Hodges sold at around $35 in early 2005, sometime after an annual meeting at which executives of the still-unprofitable firm "spoke about subscriptions, but said nothing about making money." His thesis of how subscription levels would help the firm's financials hadn't played out as expected; the stock seemed pricey.
His decision to sell proved astute, since he bagged a tidy profit and the shares started sliding soon after. XM Satellite closed Friday at $17.12. a share. Mr. Hodges's firm recently repurchased the stock at a much cheaper $10.
Keep an Eye on Trends
If the market appears to be trending lower, investors may want to pare their positions slightly, suggests Mr. Morgan of Synovus. But "you don't want to sell out completely," he says. "You want to take some money off the table to preserve capital and then re-examine the market at a later date."
At such times, investors may want to first pull out of their smallest, riskiest and most volatile holdings, says Scott Billeadeau, director of small- and mid-cap growth strategies at Fifth Third Asset Management in Minneapolis.
That said, some professionals believe investors can generate solid returns by focusing solely on finding promising stocks -- and not trying to "time" the market.
"A lot of times when things look the bleakest, is when the market does well," says Mr. Hodges. "We've given up on the market prediction business and just focus on individual companies."
Compare P/E to the Past
Investors should consider selling a stock if its price-to-earnings ratio rises well above its historical levels, says Mark Coffelt, chief investment officer for the Texas Capital Value Funds in Austin.
But a slight overvaluation may not be a sure reason to sell, he has found. Mr. Coffelt's firm bought employment-services concern Manpower (MAN) in 2005 at a P/E ratio of 19 -- lower than its historical average of about 21 -- and sold last year at around $62, when the ratio was 22.
The stock rose about 40% over that period, and the holding period was long enough to qualify for long-term capital-gains tax treatment. Still, the stock has risen further, closing Friday at $76.43.
"It wasn't severely overvalued, and we could have held it a little longer," Mr. Coffelt now says. "In hindsight, you always know what you should have done."
http://online.wsj.com/article/SB116873345610176393.html
Related:
The Anxiety of Selling
Taking Profit and Reducing Serious Loss
It's Time to Take Some Profits
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