Is it time to sell the dogs in your portfolio?
A recent wave of corporate mergers, interest rate hikes, continuing downsizings and restructurings by major companies, opinions of an overvalued stock market--among other things--are making this question pivotal for many investors, some experts maintain.
Selling at the right time can drastically improve your investment results. But no one likes to talk about selling, experts say. Instead, investors who buy a stock or mutual fund that loses ground--or changes so drastically that it no longer suits their investment goals--tend to hang on, hoping against hope that the investment will come back, says Michael Wilkinson, president of ADAM Investment Services in Atlanta.
"Nobody wants to admit that they made a mistake," says Wilkinson. "If they only talk about the winners and about where next to invest, they never have to say, 'Golly, look at the dumb thing I did here.' "
How do you determine the right time to sell? There's no simple answer, but here are a few factors that experts say you should assess:
* Market conditions. If you invest in individual stocks or in "sector" funds--those that concentrate on specialized industries--consider how overall market trends will affect your portfolio. Will interest rate hikes decimate the earnings of your bank and utility stocks? Will the success or failure of health care reform benefit or harm the value of your biotechnology, health care or tobacco stocks? If all of your investments are in industries unlikely to be scathed by pending change, move on to the next consideration.
* Price-earnings ratios. Measurements of how a company's selling price compares to its earnings are a good measure of whether the stock is undervalued, overvalued or about right.
However, there is no "right" range that applies to every company, says Stephen W. Boesel, president of Baltimore-based T. Rowe Price's growth and income fund. The way to evaluate a price-earnings ratio is by reviewing company history, he says.
Value Line investment reports--available at many public libraries--show the past levels of individual company price-earnings ratios. If your company's ratio is currently at the high end of that historic range, consider whether the company's size and earnings are set to grow faster than normal. If not, it may be time to sell.
* Dividend yields. Comparing a stock's dividend to its market price is also a telling indication of value. If today's dividend yield is historically low, it may be because the company's market price is too high and set for a fall--another bailout signal.
* Corporate change. Mergers, restructurings and sales of subsidiaries can cause companies to change direction. If your companies have drastically altered their business lines, consider whether you're still comfortable investing with them for the long haul.
* Results. If the stock you buy loses 10% of its value right off the bat, you should sell it, says Ernie Mysogland, executive vice president and chief investment officer of NWNL Northstar Funds in Greenwich, Conn. That loss is an indication that you either overpaid for the stock or were mistaken about its fundamentals, he says. Don't be thrown for a loop if share prices fall back a bit once they've appreciated, though. The rule of thumb is to sell losers and let the winners ride--at least until they hit their target prices.
* Price targets. Normally, you should buy stocks when you think they're undervalued and sell when you think they're fully valued, says Mysogland. That means you must take a close look at a company's fundamentals--such as price relative to earnings, dividend yields and growth prospects--and have a clear idea of how high the stock should go to account for the company's underlying value, the "target price." For instance, you may think a stock that's selling for $20 is worth $30.
Remember the target price. And once you hit it, sell, Mysogland says. It may be that the stock rises higher. But unless the company's prospects changed between your initial evaluation and when it hit the target price, you're better off getting out while the getting's good.
* Fund performance. When you invest through mutual funds, you rely on a fund manager to analyze the fundamentals of each stock. You analyze managers by paying close attention to their performance relative to that of other similar funds. In other words, compare growth funds to growth funds, global to global and so on.
As a rule of thumb, buy based on close analysis of five years' worth of strong performance but sell based on shorter-term results--just four quarters, says Wilkinson. Don't sell a fund just because it's not in the Top 10. But if it's not ranked among the top 50% of funds in its category for four quarters in a row, it's time to look for a better option, he says.
Others say you should watch a little longer--between five and six quarters. And you should be more apt to switch if there have been significant changes in the direction or management of the fund.
"If one-year performance is lagging and it's in conjunction with a policy change, investment strategy change or manager change, then that fund ought to be on watch," says Craig Litman, principal in Litman/Gregory & Co., a San Francisco-based investment management firm. "If there has been no major change in direction, you should give it a little more time."
In any case, more than 18 months of lagging performance is a sell signal, these experts maintain.