MARKET BEAT : Deciding When to Sell a Stock That’s Dropping : Investing: In some cases, it’s better not to bail out when shares first begin to head south.
When a tree falls in the forest, maybe nobody hears it but the spotted owls. But the number of stocks falling like trees on Wall Street lately has left a resonating sound in the ears of many investors.
A lengthening list of companies have zinged the market with lousy earnings reports, dismal sales projections and assorted other bombs. Investors, in no mood for disappointment with stocks at their current lofty levels, have responded by mercilessly slicing 15% to 30% from the offending stocks within minutes of the bad news.
The severity of the stocks’ one-day declines raises a major question: Is it typically smarter for the individual investor to sell into such blowouts, or should you wait to make a move after the dust settles?
That question is likely to be asked much more in coming months, as the market struggles to find direction and investors grow increasingly sensitive to bad news.
Some recent examples suggest that selling in the heat of the moment often is a mistake. The accompanying charts show the trading patterns of three firms that were casualties of their own press releases:
* Consumer products firm Stanhome Inc. dropped 20% on April 25, to as low as $32.375, after it reported sharply lower first-quarter earnings. But the stock closed at $33.625 the following day.
* Santa Barbara-based medical products company Mentor Corp. plummeted 26% on April 15, to $19.375, following the federal government’s decision to allow only limited medical use of Mentor’s new anti-incontinence drug. The following day, however, the stock rebounded to $21.75.
* On the other hand, Compaq Computer plunged 15% on April 25, to $52.50, after forecasting lower second-quarter earnings. And the following day Compaq kept falling to close at $50.875.
So in two of the three cases, the stocks exhibited what Wall Streeters refer to as a “dead-cat bounce”--the price rebounded from the low reached immediately after the bad news, like the proverbial dead feline bouncing after impact.
Then, in all three cases, the stocks fell even lower within two or three days of the initial plunge.
The chance of a dead-cat bounce suggests that investors who want out may be better off waiting until the following day to sell--but not much longer than that. What you’re hoping, of course, is that some knee-jerk bargain hunters will rush in the day after the plunge to erase some of the damage done by the knee-jerk sellers.
But William Duncan, principal in Duncan-Hurst Capital Management in La Jolla, argues that “there’s no percentage in trying to outmaneuver these situations. Sometimes you get a dead-cat bounce, and sometimes you don’t.”
One unpredictable influence is the market mood overall. A rising market may raise the odds of a second-day rebound, and a falling market may guarantee that there is none.
And in general, Duncan says, the smaller the stock, the less chance of a bounce.
More important than trying to play a bounce, experts say, is calmly trying to synthesize the cause of a stock’s decline as it occurs and deciding if your reasons for owning the stock have disappeared.
Even if the market is destroying a stock, an investor shouldn’t assume that sellers are acting rationally. Traders whose time horizon extends only a few months may have no choice but to exit on disturbing news, even if they figure that the stock will be higher six months later.
Richard Carney, principal with money manager Cramblit & Carney in Los Angeles, notes that when a stock tanks, “A lot of people stampede out to pretend like they were never in it.”
Long-term investors, however, have to disengage themselves from the panic of the momemt. “You’ve got to understand why you own the stock, or the emotion will overwhelm you,” says Dick Weiss, co-manager of the stock mutual Strong Fund in Milwaukee.
“If the company’s problem doesn’t involve your core rationale for owning the stock, then you’re probably better off keeping it” than bailing, he says.
For example, stocks sometimes sell off on reports of lower quarterly earnings, even when the decline is caused by a one-time charge (say, for a plant writeoff) rather than by a problem in the company’s ongoing operations.
Indeed, sometimes the best perspective an investor can get is to look at 10-year price charts of the stocks in one’s portfolio. (Value Line Investment Survey is a great source for that kind of data.) You may be surprised to see how many times companies with great long-term stock records have stumbled briefly along the way.
In the case of Stanhome, Carney says the 32% first-quarter decline in earnings doesn’t change the long-term outlook for the firm, which makes household chemicals for direct sale to consumers (via neighborhood parties) as well as porcelain figurines and other gifts. The first quarter’s problems stemmed from consumers’ reluctance to open their pocketbooks with the Gulf War going on.
Carney, who owns the stock, says he held through the selloff because he still sees Stanhome’s basic story as being intact: a consistent long-term earnings growth record, virtually no debt and a high return on equity (28% annually in recent years).
The pros also admit, though, that when a stock’s story has changed--and you have reason to believe that the company’s problems may take at least several quarters to work through--you shouldn’t try to talk yourself into holding on. “Avoid rationalizing your performance,” warns Weiss.
He sold his shares of long-distance phone company MCI Communications last year, for example, when it became clear to him that the company’s earnings problems were signaling a fundamental change: “They weren’t going to continually pick up market share, as we had thought.”
Granted, it’s tough for smaller investors to reach those same conclusions as quickly as big investors, given the latters’ access to up-to-the-minute information on a company’s prospects. Ultimately, many individual investors have to go on gut feeling--and faith--when deciding to hold on to a stock rather than sell.
But at the very least, the typical trading patterns of stocks that suffer bad surprises suggest that you have a couple of days to make your selling decision with a cool head. If the stock is going to drop further in the short run, the second wave of selling usually doesn’t begin for two or three days after the first shock.
Briefly: Standard Brands Paint Co., the troubled Torrance-based home decorating products retailer, still hasn’t released its proxy statement for the annual meeting scheduled for May 24. The company is the target of a proxy battle by a Kansas City, Mo., investor who owns 15.8% of the stock.
In addition, a group of Standard’s employees has organized the “Concerned Employee Ownership Committee” and has filed its own proxy with the Securities and Exchange Commission. The group, allied with the United Food & Commercial Workers Union, is asking that shareholders void employment agreements for Standard’s top management. The agreements guarantee severance payments if the executives are fired for anything other than criminal actions. . . .
For individual investors who are do-it-yourselfers with small stocks, the National Assn. of Securities Dealers has published its 1991 NASDAQ Fact Book and Company Directory. The 231-page book has 1990 price information on more than 4,000 NASDAQ stocks, as well as addresses and phone numbers for all NASDAQ companies. (Handy when you want to get an annual report or other information on a stock.)
For a copy, send a check or money order for $15, payable to NASD, to: NASD Inc., Book Order Dept., P.O. Box 9403, Gaithersburg, Md. 20898-9403.
When High-Fliers Take a Hit When a stock suddenly is smashed because of surprise bad news, investors have to quickly decide whether to exit with the crowd or hang on--for a bounce or for the long-term. How three recent high-fliers fared in the aftermath of sharp declines:
COMPAQ: Friday close: $50.75 STANHOME INC.: Friday close: $33.25 MENTOR CORP.: Friday close: $19.00
