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Is that stock a sell? 5 key tests
So you're way up on an oil stock or gold play, you're getting nervous and you feel the urge to sell? It's time to do some research. To avoid big mistakes, apply these five tests.
By Jim Jubak
Are you about to sell the wrong stocks? Again?
Admit it. We all make too many of our sell decisions based on the fear that somebody is about to take our gains away. I do it. We all do it.
Despite the time-tested Wall Street advice to sell your losers and let your winners run, investors tend to do just the opposite. We sell stocks with price momentum and with strong and improving fundamentals, just because they've gone up in price. And we hold onto the dogs that no one is buying and where fundamentals are weakening, just because we cling to the hope that we can get even.
A tide of nervousness
And if my e-mail is any guide, some of us are about to do it again. I can sense the nervousness rising. If you were fortunate enough to get in on oil or copper or coal or gold stocks before they really took off, you're looking at huge gains. Peabody Energy (BTU, news, msgs), Goldcorp (GG, news, msgs) and Schlumberger (SLB, news, msgs), for example, are up 187%, 156%, and 101% in the 12 months that ended on April 26. And these are exactly the stocks that you're thinking of selling.
The most important bit of investor psychology for our purposes is something called "loss aversion." Research in behavioral finance shows that investors prefer avoiding losses to making gains -- fear of loss is about twice as powerful as hope for gain. So every dollar's appreciation in a stock we own just ratchets up our fears of loss far more powerfully than it increases our hopes of gain. That makes it harder to hold on. (The desire to avoid a loss also shows up in a tendency to take inappropriate risk if it offers the possibility of getting even. That's one reason we hold onto dogs even if there is evidence that a falling stock will fall further.)
Related news and commentary on MSN Money
So, before we pull the trigger on any sell decision that we'll regret down the road (if we're honest enough to face up to it, that is), let's take a deep breath and review one strategy for how to sell. I'm going to use the stocks in Jubak's Picks as my examples, but I think the lessons are applicable to just about anything you own.
How to sell in five easy lessons.
No. 1: Review why you bought the stock in the first place. Has the company delivered the results to support your investment thesis, or are the results you hoped for delayed, perhaps forever? If your investment thesis is broken, the stock is a sell. If the results are merely delayed, look to Lesson No. 5, setting a target price to see if the potential gain justifies the wait.
So for example, I added Grant Prideco (GRP, news, msgs) to Jubak's Picks on Dec. 12, 2005, on this investment thesis:"Somebody has got to make the things that go into drilling rigs, and in the markets for premium steel tubing and drilling products, that somebody is often Grant Prideco. (The company controls nearly 50% of the drilling-products market.) The company's order backlog climbed to $742 million at the end of the third quarter -- not bad for a company that did $946 million in sales for all of 2004. As a manufacturer with a high percentage of fixed costs, Grant Prideco should see earnings soar as volumes increase." The pick looked a little dicey in mid-February when the company reported earnings growth of 140% but projected just 37% to 49% earnings growth for 2006. Shares fell from $51.50 on Feb. 13 to $36.57 on March 9. But I thought my investment thesis remained intact, even if Wall Street didn't agree. The company's backlog of orders continued to build. The company's second-quarter results and upwardly revised guidance for 2006 confirmed that thesis.
If Grant Prideco isn't a sell because my investment thesis isn't broken, Sysco (SYY, news, msgs) increasingly looks to me like it might be. I bought the stock because I thought the company was about to experience improved profit margins. The improvement has been slow to materialize, and I'll be looking to the company's May 1 earnings report to see if my investment thesis is broken and if Sysco is a sell.
No. 2: Has the stock become just too popular? Stocks climb because investors who don't own shares decide to buy shares. (Hey, I've never claimed this stuff is rocket science.) So while you'd like to buy into shares that have been discovered (or are about to be discovered) by enough other investors to start the price moving upward, you'd also like to know that there's a sizeable reserve of investors who don't own the stock now who are likely to buy it in the future. If it looks like everyone who is coming on board is on board, it's time to sell.
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