Happy Valentine's Day!
Welcome to this session on the challenge of making sell decisions with our stock portfolios. If you find that even thinking about selling one of your stocks makes you uncomfortable, you're not alone. Selling a stock is rarely easy. But the decision to sell examines the same factors used to select the stocks in the first place. Most NAIC investors become reasonably comfortable with stock selection fairly early in their NAIC experience. The same discipline can be extended to the decision process for selling stocks -- answering the challenge of reason.
Take a deep breath. It's not un-American to sell a stock. In an informal survey of investment clubs taken by Better Investing a few years ago, we discovered that many clubs have a portfolio turnover rate of low single digits -- in fact many of the responding clubs had zero turnover. Is every purchase decision that we make a GREAT decision? Do conditions ever change (read deteriorate) at the companies we own? Do you believe that "Stock prices fluctuate?" In other words, do you believe that buying opportunities present themselves as stock prices plunge and we discover undervalued situations? If this is true, then what about selling opportunities? Has anybody ever called you "stubborn?" (grin)
How much do we compromise long-term performance by being stubborn and refusing to improve our portfolios when it's time to do so?
A few years ago, in one of my investment clubs, we were blessed with the purchase of QUALCOMM (QCOM) at split-adjusted cost basis of $2.04. A mere 4-5 years later, QCOM had rocketed to $100 as 1999 drew to a close. The motion to sell it was greeted with, "But what about the capital gains?" Another club member suggested that if it went down, and we sold it, we'd have fewer taxes to worry about??? Besides, we could then replace it with some other stock from the industry group that would probably have gone down also???
You know the rest of the story. Our capital gains challenge "went away." We did sell a few shares at $70 or $80, but the tax tail had wagged our decision dog once again. Don't let taxes interfere with doing the right thing when it comes to portfolio design and decision-making.
Reasons to Sell
Over the next few days, we'll discuss and explore the challenges of making selling decisions. Ellis Traub, in one of his presentations, makes the point that it's not really a question of WHEN to sell. It's more a question of WHY. I agree. The selling challenge should be approached with the same unemotional attitude that we use when performing our stock selection analysis. In an article published in the September 2004 issue of Better Investing, "Selling Stocks: The Challenge of Reason," I shared three simple reasons for making sell decisions with our portfolios.
The word "portfolio" is CRUCIAL because the decision should ALWAYS be portfolio-centered. The three reasons are:
(1) Because you need the money.
(2) Because your company is weakening and fundamentals are deteriorating.
(3) Because you can make the portfolio BETTER.
Show Me the Money!
The first reason is personal. The circumstances of life dictate a need for money from time to time. The need can range from emergencies like replacing a furnace or vehicle to rewarding ourselves with a relaxing cruise to Alaska. Others may include a lump sum charitable contribution or funding a college experience. We all experience these situations.
In our family, we keep a fairly small amount of money in a money market account. The rest of our funds are invested, and generally nearly 100% invested in stocks. I'll admit that it took a while to convince my spouse that it was a simple matter to sell a stock in the portfolio and nearly instantaneously write a money market check to make the funds available.
She asked, "Well... which stocks are candidates for sale at any time?" My answer: "They all are." When one of these situations presents itself, we take a deep breath and update all of our stock studies for the family portfolio. In order to generate the funds, we'll sell the stock with the lowest expected returns and keep selling until we have the necessary funds. Hopefully, we'll never sell all the stocks before we have the money we need. (gulp)
To illustrate this, the second attachment provides a dashboard view of a typical portfolio. The dashboard provides a summary of how much each position is worth, the expected return (PAR) from a current stock study, and quality rating (on a 0-to-100 scale, >65=Excellent, 55-65=Good, 45-55=Fair, <35=Weakest). Other important characteristics include: sales growth forecast, projected average P/E ratio, financial strength and EPS predictability according to Value Line. Take a look. If you needed $2000, which stock would you sell first?
What if you needed $4000?
If it were my situation, I'd first sell Circuit City and write us a $2000 check from the money market. This also eliminates a relatively small position. The Circuit City holding was not going to significantly affect the overall performance of this portfolio no matter how much the price advanced. If more funds were necessary, I'd probably sell the Apple Computer position. (No angry letters, please.) This is an unemotional decision that probably reflects the price advance that has occurred with the Ipod fervor. Besides, the portfolio has more than one computer company and this town isn't big enough for more than one.
What would you do? There is no single correct answer. As we'll see tomorrow and the next day, we could also use this need for cash to work on the portfolio quality and expected returns, too.
The important thing is to remain unemotional and immune to that Cupid-like feeling of attachment to our long-term holdings. It's NOT un-American to sell a stock when you need the money.
Workshop Chat - NAIC Forum Chat Center
During this workshop, I'll spend some time in the Workshop Chat room (see the left hand sidebar.) I'll be in the chat room on Tuesday and Thursday nights at 9:01 ET and would be willing to discuss the workshop and answer any questions you might have. Thanks!
Best wishes and Better Investing,
Mark Robertson
References:
Better Investing, September 2004 "When to Sell? The Challenge of Reason" http://www.better-investing.org/articles/bi/1260/9302
If you needed $2000, which stock would you sell first?
Nancy CraysNAIC Forum - Long term investing made simpleClick on the Forum name to visit us
For those without Powerpoint a free viewer is available at:
http://search.microsoft.com/search/results.aspx?st=b&na=88&View=en-us&qu=powerpoint+viewer
You can choose between the new viewer for Powerpoint 2003 and the older version for 2002 or earlier.
I've used the older version, but can't vouch for the newer version. You need the newer version to open Powerpoints created in Powerpoint 2003 I believe. The latest 2003 version should work for all presentations created with Powerpoint 97 and later
.
Nancy Crays: "I would sell Circuit City and Rite Aid."
Absolutely. Nancy's point illustrates the concept that sometimes it doesn't matter what the expected return is. Even if the PAR for Rite Aid were 42%, it's an extremely speculative situation, and as we'll see going forward, it's important to take care of the WHOLE portfolio while we're making our decisions.
A Financial Strength rating of "C" from Value Line (0% in the numerical translation that I use) is the lowest possible rating. Any company with a "C" is probably facing bankruptcy or an extremely turbulent road ahead. With thousands of higher quality alternatives, most of us would rather avoid speculative roller coasters while we seek solid long-term returns.
If it were my portfolio, I'd be snatching those Rite Aid dollars and switching them to CVS, post haste.
Thanks, Gary. This ice storm roll through central Illinois?
I'd also offer to send PDFs to anybody who struggles with the Powerpoint viewer.
No ice here just a lot of rain and 50 degree weather. VBG
I notice a good correlation between the quality rankings and what I'm seeing on the SSG's.
So the moral of the story is to sell the lowest quality first regardless of the projected return?
I've attached a ToolKit database with OPS data for this portfolio.
Gary Simms said: "I notice a good correlation between the quality rankings and what I'm seeing on the SSGs. So the moral of the story is to sell the lowest quality first regardless of the projected return?"
Could be, but I think the moral is that both quality and projected returns matter. I don't want to get quite that absolute about it. I think each holding has to be examined on a case-by-case basis. For relative beginners, the answer is probably yes. But I'm stubborn (grin) and still hold the opinion that special situations are OK to pursue for more experienced investors -- so long as they maintain a solid core of high-quality holdings to complement their more speculative selections.
I've been studying the words of Nicholson about maintaining portfolio quality and wondering if George wouldn't see the wisdom of relaxing quality constraints during periods of overall expected high returns for the market. With the projected annual return for the total stock market hovering around 20% some 18-24 months ago, it certainly made sense to compromise (slightly) on quality to get some of those promising smaller companies. The smaller companies often do the best coming out of a recession.
I could be wrong, but I keep getting this mental image of painting myself into a quality corner. If I always switch to higher quality when making portfolio challenges, what do I do when I own the 16 highest quality stocks? (grin) The answer might be, "Buy an island," but I doubt it. I think it probably makes more sense to recognize that the NAIC "absolutes" really are directed at providing guidance for beginners. The guidance needn't be -- always higher quality, but always "prudent and carefully considered." Under that type of guidance, an experienced investor is freed during the later stages of bear markets to pursue some slightly lower quality, but much higher expected return stocks.
Brian Lewis President, Puget Sound Chapter NAIC Director, NIA Advisory Board http://www.nwlink.com/~brianle/
If I always switch to higher quality when making portfolio challenges, what do I do when I own the 16 highest quality stocks? (grin) The answer might be, "Buy an island," but I doubt it.
Mark,
I thank you as well for running this workshop for us.
I am one of those investors who has a terrible time when it comes to selling.
I believe I should sell UTStarcomm, for example, because it doesn't seem to me that the management team is in control. They are expanding their product line and expanding their global reach but the last two quarters have been horrendous, including a serious downtrend in trailing pretax margins. There are definitely issues. Then I can't help thinking....... what if they pull it off? What if their consultants get them back on track? They are expanding into Japan, India, South America and so forth. And they do have a 50% share of the China market for their products although under increasing competition and although I believe it used to be a 70% share.
I suffer from the "but what if......." syndrome.
MGIC is another concern. I really believe that company has seen its best days. But I do show an 8.4% total return. Without a replacement waiting by, I can't rationalize putting these funds into INGDirect at 2.35%.
Then there's KIMCO, which I consider to be a fine company. My SSG shows it in the sell zone with a u/d of .2 and a relative value of 155.3% (based on price to FFO). But again,due to the 5.6% dividend yield, the total return becomes 7.5%.... so I continue to hold.
I did sell Mity and I'm holding more cash than I have for a long time. So.......I do nothing.
I am working on my watchlist since the decision to sell these stocks will be easier if there are replacement stocks waiting in the wings. That project seems to be consuming a lot of time which is in short supply.
I don't expect any magic answers, but thought I'd just comment on my own personal issues re selling.
Nancy IsaacsNAIC Forum - Long term investing made simplehttp://community.compuserve.com/naic
I believe I should sell UTStarcomm, for example, because it doesn't seem to me that the management team is in control. They are expanding their product line and expanding their global reach but the last two quarters have been horrendous, including a serious downtrend in trailing pretax margins. There are definitely issues. Then I can't help thinking....... what if they pull it off? What if their consultants get them back on track?
All,
This workshop is very timely for me, because I'm trying to decide whether or not to sell KBH. I've been an NAIC member for about a year, and KBH is a hold-over from my pre-NAIC days.
KBH has appreciated nicely, but I think it may be over valued now. I have no problem with the emotional aspect of selling. I just want to be reasonably sure that the signals indicate sell rather than hold.
I'm using Toolkit 5 and OPS data. First of all, the quality look fine to me, so this is not a case of deteriorating fundamentals. (Although I am aware an analyst last week downgraded this and several other homebuilders from buy to hold, and KBH responded by losing a few points.)
My current conservative SSG forecasts sales growth at 15%, EPS at 13.5%, and has a high average PE of 7.4 and low average PE of 4.4 (with high PE's of 8.1 and 8.2 and low PE of 5.3 set as outliers). This gives an average PE of 5.9, and with a current PE of 10.0, results in an RV of 165.9%. U/D is 0.7 and PAR is 3.2%.
My current optimistic SSG (taking a clue from Nancy Isaacs' Simply Put article, Selling an Overvalued Company) forecasts sales growth at 20% and EPS at 28%. With no outliers in section 3, current PE is 6.1 resulting in an RV of 163.9%, UD of 2.5, and PAR of 16.6%. This is just barely out of the buy zone.
These two SSGs give widely divergent results. What worries me in both of them is the RV greater than 150%. I like the 16.6 PAR, but KBH just doesn't get the PE respect that its railroad tracks and growth rate deserve, IMO.
I would appreciate your comments.
Over the next few days, we'll discuss and explore the challenges of making selling decisions. Ellis Traub, in one of his presentations, makes the point that it's not really a question of WHEN to sell. It's more a question of WHY. The selling challenge should be approached with the same unemotional attitude that we use when performing our stock selection analysis. In an article published in the September 2004 issue of Better Investing, "Selling Stocks: The Challenge of Reason," I shared three simple reasons for making sell decisions with our portfolios. The word "portfolio" is CRUCIAL because the decision should ALWAYS be portfolio-centered. The three reasons are:
When the Wheels Come Off
We took a look at the first reason yesterday. It was personal and driven by the challenges or needs of our personal situations. The second reason is "somebody else's fault." It's not even necessarily something that's the fault of our management team. I'm sure the last buggy whip manufacturer standing had a pretty good product when they shut off the lights for the last time. (grin) Sometimes it simply IS the fault of our management team and we need to hire a new one. With common stocks, this is easier than it is when it's personal and we're directly involved. If our management team is failing to recognize opportunities and profitably capture them in order to build shareholder value, it's probably time to locate that SELL button on your brokerage transaction screen and press it.
Phil Keating tells a story of two lists that he keeps in his pockets. The first list of companies are leadership companies that he owns because of an outstanding management track record. The title at the top of the list is: "Companies to Sell if the Corporate Jet Goes Down."
The second list is a set of promising companies that never seem to quite seize the opportunities. They might be on the verge of being a good, maybe even great, company but never seem to effectively operate their business to grow and sustain profitability. But... after careful review, he knows that in the right hands... The title at the top of this list is (you guessed it): "Companies to BUY if the Corporate Jet Goes Down."
It's a morbid way to make a point and I apologize, a little. It underscores the reality that our management team has but one mission for the companies that we own. The mission is to grow -- profitably -- and at a rate better than their competitors. We expect them to manage their capital resources effectively and to have financial strength. We expect that they will manage operating costs and exploit markets with a degree of consistency and predictability.
When they don't -- when the wheels start to vibrate -- it's time to head for the hills, hopefully before the wreck starts.
What are declining fundamentals?
It's not an easy question. To me, it's when the sales growth and profitability expectations begin to decline -- and it's particularly true when the decline is significant compared to any company's peer group. In other words, if the profit margins are eroding (declining) while everybody else is advancing -- something is clearly wrong.
If you use the NAIC stock selection tools, monitor the %PTP trend using the PERT-A graph. Declines here should be taken very seriously. It's a red flag and you need to do some comparisons to see the trend is company-specific or whether it's pervasive throughout the industry. If you can attribute the challenges to a recession and you like what you're hearing from management, you can take down the red flag.
My preference is to monitor the quality rating, a 0-to-100 scale based on relative growth, relative profitability, financial strength and EPS predictability. We'll use yesterday's poster child, Rite Aid, to illustrate. The first attachment provides a historical look at quality and expected returns for Rite Aid. This chart is my version of portfolio analysis and you can think of each point on the x-axis as the results of a quarterly stock study. The green bars are split-adjusted stock prices. The red line is the projected annual return (PAR) and the blue line is the quality trend. Remember, >65 is an excellent company, ranking among the top 20% of all rated companies. In this case note that Rite Aid was a good, even excellent, company well into 1998. The stock price peaked during late 1998. A slight "down draft" in the quality rating actually begins in early 1998 and at some point, mid-year, Rite Aid shuffled into a "Good" quality rating with a rating between 55-65. The decline continues and accelerates during 1999 before falling off the quality cliff in October 1999.
At what point does a quality down draft get my attention? A yellow flag goes up after the third consecutive quarter of declining quality and I'll explore a little more closely. I heed the words of Brad Perry. Continuously ask: "Does the company lack the strengths and favorable long-term prospects I saw when I bought the stock?" But it pays to be patient, hence the nine month period. "Investors should not rush to judgment when a hitherto strong company hits an air pocket."
For Rite Aid, this wasn't an air pocket, at least one of the engines fell off the "plane." See the 2nd and 3rd attachments. Profit margins were hammered for a number of years, finally showing a glimpse of return to profitability in 2004. The visual analysis says it all. The point is that by monitoring the quality, it's not likely that the stock would have been sold at $50, but there's a pretty good chance that -- following this philosophy -- it may have been sold between $15 and $30.
I'll take a look at the holdings to see if any of them are caught in a quality down draft and post what I find.
Do any of you have companies that you think are examples of quality in decline? Talk about them here. The turnaround trap is a terrible temptation for investors. I've been there and done that. We're naturally optimistic or we wouldn't be here in the first place. When faced with deteriorating fundamentals, it's really, really tempting to listen to management's fearless forecast of a return to growth and profitability. It's important to remain unemotional. Facts and results matter more than hopeful prognostications. What do the trends tell you?
Be willing to push that SELL button. Your portfolio will probably be better, in the long run, for your courage.
Looking at your Price, PAR and Quality graph, I believe I would have been inclined to sell Rite-Aid in mid-to-late 1998. Hindsight being what it is, I know that is easy to say.
Although I have a difficult time selling a relatively high quality stock, verified by not having specific sell parameters, I'm managing to apply sell considerations better and better <g>. I purchased Scansource (NASD: SCSC) in late 2003, and unloaded all of it in January, '05, as it had reached my 5-year projected price in just about 12 months. Good company, tho!
Hope to be able to consolidate this entire presentation for an education session for the Chapter, if that's OK with you.
Regards,
