See Jim's new portfolio to help navigate the treacherous interest-rate environment.
Jubak's Journal Recent articles: • Oil substitutes? Try these 5 stocks, 4/26/2006 • Energy still the key for income investors, 4/25/2006 • Why interest rates will march higher, 4/21/2006 More... | Jubak's Journal 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
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
If Grant Prideco isn't a sell because my investment thesis isn't broken, Sysco 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. There are lots of ways to judge this. From the stock chart you can look for danger signs, such as falling volume on days the stock climbs in price. You can check under Financial Results, Key Ratios (click here and punch in a stock symbol) to see how the stock's price-to-earnings ratio compares to that of the rest of the market. If the stock is already selling at a premium to the market, expanding the multiple that investors are willing to pay for earnings gets harder. And you can check to see how the stock reacts to good news. If the reaction is muted, it suggests that there aren't a lot of investors waiting to jump on board. That's exactly what worries me about the market reaction to PepsiCo No. 3: Look for specific danger signs. For many investors, insider selling is a big red flag. Now that so many companies have set up automatic timed sales programs for top executives in an effort to avoid shareholder suits if the stock drops just after an insider sells, I suggest looking not just for insider selling but for a surge that's above normal selling patterns. I also look at the company's chart to see if the stock has gone parabolic. If a stock that has been trending upward at a steady or steep pace suddenly spikes upward toward the stratosphere, there's a good chance that you're looking at an unsustainable gain that will fall back to the former trend line. Depending on the stock, the size of the spike, and the place of the stock in your portfolio, this could be the sign of a good time to sell. No. 4: Think ahead six months, a year, five years -- whatever time horizon you consider in your strategic planning. Is the stock a critical part of executing that strategy? So for example, I think inflation is moving higher over the next three years, and owning gold is a key part of positioning my strategy for that. Selling because the stocks in the sector are ahead of the fundamentals -- which I think they are -- and then attempting to buy them back requires me to get two timing calls correct. (And I need the market to oblige with a correction back to what I regard as fundamental values.) If I'm working in a taxable account, the sell would also generate a tax event. So because gold is strategically key to my portfolio, my thoughts of selling turn to a conviction to hold. No. 5: Set a future target price. Is your projected gain enough to make it worth owning this stock going forward? Forget about how far the stock has climbed while you've owned it -- that's all in the past (and you can put it in the bank if you decide to sell.) What you want to know now, you ungrateful thing, is what this stock can do for you tomorrow. For example, I bought shares of oil-drilling equipment company Ensco International And perhaps even more importantly for a cyclical stock such as Ensco International, it's starting to become clear to investors that this cycle still hasn't peaked, and that Ensco will see increased revenue and earnings growth into 2007. Using even the Wall Street consensus earnings-per-share projections for 2006 and a multiple of 14.6, a blend of the price-earnings ratio in 1997-1998, the last revenue peak for Ensco, I get a price target for December 2006 of $70 a share. That's a projected gain of 25% in eight months from today's price, and that's certainly enough to justify holding rather than selling this stock. That's it. Five tests to apply to the stocks you own when you feel the need to sell them. And even when you don't. No reason to apply these lessons just to your big gainers. These five lessons are a good way to weed the losers out of your portfolio as well. Updates Stocks for the 2006 commodities crunch Suspicions were back on Feb. 8 when Grant Prideco How the Fed lost the inflation fight I added Ensco International New developments on past columns Bad for GM, bad for America It's not big money but still it's hardly a vote of confidence in the future of General Motors Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For suggestions to help navigate the treacherous interest-rate environment see Jim's new portfolio Dividend stocks for income investors. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: Ensco International, Goldcorp, Grant Prideco and PepsiCo. He does not own short positions in any stock mentioned in this column. | |||||||||||||||||||||||||||||
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