The Kenny Rogers Investing Theory: Ya Gotta Know When to Hold . . .
Buying a stock is easy. Figuring when to sell is the hard part.
That decision may be tougher than ever this year for many individuals, whether short-term traders or long-term investors.
Market volatility has been terrible in recent months, producing big up and down spikes in many stocks without apparent reason.
What’s more, some of Wall Street’s favorite growth stocks of the 1980s--such as health care issues--are in a free fall, leaving longtime share owners fearful that their large paper gains may soon evaporate.
How do you know when to call it quits with a stock? We put that question to some pros who’ve racked up great investment records in recent years, as tracked by Money Manager Verified Ratings of Beverly Hills. Here’s what they said:
* Sell when the company story changes. When something material changes in a company’s outlook, it’s time to re-evaluate. This sounds basic, of course, but investors who fall in love with certain stocks often choose to ignore trouble signs.
A slowdown in earnings growth--however small--usually is the best reason to exit a stock, says Cedd Moses, who manages $40 million for the firm Portfolio Advisory in Los Angeles.
“When a company starts to show slower earnings growth, it’s either because its margins are shrinking or because (sales) are slowing,” he says. Either way, “It’s often a sign that there might be bigger problems coming,” Moses says.
Drug stocks, for example, are plunging in part because many of the firms are posting lower-than-expected quarterly earnings. The results aren’t off by much, but rightly or wrongly some investors see the bigger risk in holding on.
* Sell when the stock story changes. Sometimes a company’s fundamental story remains bright, but its stock begins to act badly. This is often true of highly volatile stocks that have had tremendous run-ups in a short period.
If you’re more of a short-term trader than a long-term investor, the stock story may be more important to you than the company story. Once a stock falls below certain “technical” levels--sometimes known only to the analysts who make a living watching stock charts--the shares can quickly collapse. They may come roaring back a few months later, but the short-term devastation can doom a trader.
Drug giant Merck, for example, on Thursday fell below its 200-day moving average price of about $142. The stock dropped $2.875 to $139.75. The moving average price indicates a sort of “floor” for a stock, which if pierced often leads many institutional investors to exit. In Merck’s case, that could force the stock down to the low-$130s before it bottoms, some traders say.
* Sell when your target is met. Whether you’re a long-term investor or a short-term trader, you should have a target in mind before you buy a stock. If you expect to make 25% on the stock, you should re-evaluate it once that goal is reached. More important, decide in advance how much of a loss you can sustain if the stock begins to drop.
“You have to decide what level of pain you’re willing to live with,” says Richard Whitman, principal at Benchmark Capital in New York. He notes that many investment pros exit when a stock falls 7% to 10% from their purchase price. The idea is to keep a minor loss from becoming a portfolio-wrecker.
Long-term investors, however, may find even a 10% loss limit too restrictive, the pros admit. “Great companies can have a lot of 10%, 20% or even 30% corrections in their stocks” along the way, Moses says, even though their fundamentals remain healthy. The key, he says, is to have your targets in place before you buy so that you’re at least forced to ask the right questions should the stock drop.
* Sell when you’ve got a better idea. A stock doesn’t have to be in a free fall to merit selling. Lori Tanner, a successful L.A.-based investor who manages $4 million for clients, has won huge with Microsoft Corp. stock over the past six years. But on the way up, Tanner has routinely sold some of the shares to invest in other ideas, she says.
The lesson is, don’t assume you’ve got to hold on to every share of a winning stock for all time. “I’ve said to myself, ‘I’ll probably own some Microsoft for the rest of my life, but I’m going to be taking profits along the way,’ ” Tanner says.
Of course, there’s a downside to selling, even at a profit: You have to pay taxes. But especially in the case of long-term investors who have big paper profits built into a stock such as Merck, selling some now can’t hurt you. If you’ve got a major winner that’s suddenly gone sour, taking out at least some of your profits will keep you from feeling a lot worse later if the stock drops far more than anyone can project.
When a Leader Cracks Here’s what long-time shareholders of drug giant Merck & Co. face: When a stock runs up almost in a straight line for seven years--and then suddenly cracks--how big a drop do you tolerate before bailing out? Merck high price each year, plus latest (NYSE trading) Thursday: 139.75 Prices adjusted for stock splits. Source: Value Line Investment Survey
