Getting a Clue on When to Buy and When to Bail Out
An old line that never loses its relevance: The only thing tougher than knowing when to buy a stock is knowing when to sell it.
With the Dow Jones industrial average at record highs, it may be more fun to think about jumping in than jumping out. But any investor with paper gains ought to take the Dow’s surge as an opportunity to do a quick portfolio review. Maybe it’s time to do a little pruning.
A lot of investors are jittery about what’s next, all right. Walter Haddad, a veteran broker at Paine Webber Inc. in downtown Los Angeles, says he’s getting plenty of calls from clients with one basic question: “They want to know if the fun is over.”
Unless you’re convinced that another crash is imminent, selling everything makes no sense. Rather, the decision has to be made stock by stock.
First, consider the basics. Any capital gain will be taxed at the same rate as ordinary income. So you’ll be giving Uncle Sam a 28% to 33% cut, and many states take a cut, too. But while taxes are a consideration, that alone never should stop you from selling, experts say.
Another basic question is, what will you do with your profits? Don’t sell until you’ve decided where the money will go, whether that’s another stock or a short-term parking place.
After covering those bases, how do you pick out stocks worth selling? Some strategies:
* Tom Anderson, a Crowell, Weedon & Co. broker in downtown Los Angeles who has been in the business for 31 years, is guided by one of the most trustworthy of all yardsticks: a stock’s price-to-earnings ratio (P/E), or price divided by most recent four quarters’ earnings per share.
“When a stock is selling for 20 to 21 times earnings, or a higher multiple than it has sold for in a long time, that’s often the time to get out,” he said. Pepsico Inc., for example, closed at $68.75 Tuesday. It’s up 7% year to date, after a 62% rise in 1989, and now sells for 20 times earnings. That’s been the ceiling on the P/E since 1980, and Anderson takes that as a sell signal.
That doesn’t mean Pepsico won’t do well over the long term, he notes. If earnings keep rising, the stock will, too--over time. But this latest surge looks spent to him, or at the very least it has raised the risk level. So it’s time to take profits.
* Has the stock had a “climax run”--a rapid, exponential rise? Morgan White, principal at Woodside Capital Management in Menlo Park, says such runs often are great sell signals.
That may appear to fly in the face of a long-held market maxim, which is that you cut your losses if a stock drops 7% to 15% from where you bought it, but that you let your profits run. However, White notes that “no stock goes up forever,” and after a dramatic rise, selling some is an insurance policy.
Look at software firm Adobe Systems. It has risen to $46.50 now from $20.25 on Jan. 1. The greed-monger in you might say, “Wait for more!” But after a stock doubles, as a general rule you might want to sell half the stake, White said.
* If your paper gain on a stock is, say, 15% to 20%, you face a tougher sell decision. Many investors feel that kind of return is all they need to justify bailing out. Some brokers disagree. “People are eager to take a small profit,” said Paine Webber’s Haddad. “But you’re going to make as many mistakes that way as selling at a loss.”
Take another look at the company’s fundamentals, Haddad advises, and remind yourself why you bought the stock in the first place. If the firm’s earnings outlook has improved dramatically over the past year, “the stock can be cheaper at $40 than it was at $20,” he said.
But above all, Haddad said, the decision to sell should be based on your “comfort” level: If you can’t sleep at night because you fear your paper gains could disappear, then sell some of your shares--even if it’s just a portion of each holding. You’ll feel better, you’ll have new capital to put to work elsewhere, and yet you’ll retain the bulk of your long-term commitment to the stocks.
Have money funds peaked?Even before the stock market reawakened with a bang last Friday, individual investors were pointing the way: They’ve been pulling cash out of money-market mutual funds since late March in favor of stock funds and other longer-term investments.
The unanswered question is, how much of the $383 billion that’s still in money funds will flow to stocks? The evidence so far in May suggests that investors’ appetite for stock funds remains strong but that long-term bond funds also are garnering a lot of cash once again.
What’s interesting is that investors aren’t fleeing money funds because fund yields are plunging. The average fund yield has been steady in the 7.6% to 7.7% range all year, notes Brenda Malizia Negus, editor of IBC/Donoghue’s weekly money fund letter. The latest figure is 7.66%.
Instead, investors must simply see better potential in stocks and other ideas. And perhaps not surprisingly, the investors who are most actively shifting money around are those who have brokers to prod them.
Money funds sponsored by brokerages have accounted for the bulk of the drop in assets so far: The broker fund category has fallen to $160 billion in assets now from $167 billion in late March. In contrast, assets of general purpose money funds, often used by independent investors, have fallen only slightly, to $132.2 billion from $133.4 billion.
Some of the decline in money fund assets has been seasonal, as investors pay tax bills. Even so, fund companies say there’s no question that a shift to longer-term investing has begun.
“We’ve seen a definite turnaround in May--investors moving into stock funds and long-term municipal bond funds,” said Greg Johnson, vice president for marketing at Franklin Group mutual funds in San Mateo.
At fund giant T. Rowe Price Associates in Baltimore, spokesman Steve Norwitz said stock fund sales are leading the wave. “Stock fund sales have exceeded bond fund sales every month since December,” he said. “That hasn’t happened since 1986.”
Investors also are moving out of tax-free municipal money funds and into longer-term municipal bond funds, Norwitz said. That’s occurring even though average yields on tax-free money funds have risen to 5.5% from 5.2% since late January, while long-term interest rates have been falling since late April. Investors obviously have one viewpoint here: It’s time to lock in long-term yields before they go even lower.
Martin Gawne, spokesman at Kemper Group mutual funds in Chicago, said money flows into the firm’s U.S. Government bond fund were strong last week. That fund’s yield now is 9.19%. Second most popular bond fund at Kemper: the Municipal Bond fund, yielding 6.87% tax free--equivalent to a 10.25% taxable yield in the 33% tax bracket.
Briefly: Securities and Exchange Commission Chairman Richard Breeden is in Los Angeles this week. He addresses the World Affairs Council on Friday at the Los Angeles Hilton. . . . William O’Neil, long-time market pro and publisher of L.A.-based Investor’s Daily, issued a super-bullish stock market forecast on Tuesday, predicting the broad market will rise 25% over the next 12 months.
THE MONEY FUND DRAIN
After peaking at $392 billion in late March, money market mutual fund assets have fallen sharply.
