How to Know When to Hold ‘Em and When to Fold ‘Em

Stock Exchange lets readers listen in as Times staff writers James Peltz and Michael Hiltzik debate the merits of individual stocks. Today, though, they discuss some common dilemmas faced by investors.

Jim: This time each year, Mike, all the media run dumb stories telling investors that they--the media--have found the 20 best stocks or the five best stock sectors for the coming year. You know the headlines: “10 Stocks You Must Own in 2000!” Even the powers that be at this newspaper urged us to follow suit. To which we said, uh, no, thanks.

Mike: That’s right. When they asked, I don’t think they knew the two axioms I’ve followed throughout my career.

Jim: Which are?

Mike: One: Make no predictions, because they’re always wrong. Two: Make all the predictions you want, because a year later hardly anyone remembers what you said.

Jim: So instead, we thought we’d go over some of the basic dilemmas that investors of all stripes often face, and offer our two cents on how to deal with them. We’ll get back to reviewing individual stocks next week.

Mike: And if the market keeps going the way it did in ‘99, this time next year our two cents will be worth, oh, about $40 million.

When Is It a Good Time to Sell?

Mike: Whenever I hear this question, the face of John Bogle immediately swims into my mind’s eye.

Jim: Bogle being the former head of the famed Vanguard family of mutual funds, the nation’s second-largest.

Mike: Bogle and Vanguard, of course, are huge proponents of stock-index funds, on the grounds that it’s hard to beat the indexes over time, almost by definition. Put another way, Bogle was a sworn enemy of trying to time your stock trades, of trying to know exactly when to buy and when to sell for optimum profit.

Jim: Fair enough. But you still need some guidelines on when to sell.

Mike: For me, a good time to sell is when you need the money.

Jim: That’s it? That’s your pearl of wisdom?

Mike: Yes, actually. Usually when I’ve sold stock it’s to buy a house, or some other time when I’ve needed cash. See, this goes back to my point about Bogle. I like to stay in stocks because I’m always afraid that if I sell, I won’t know when to get back in.

Jim: Case in point: Your investment in IBM.

Mike: Exactly. Remember I told you how I bought IBM years ago, and before long had a 50% loss? I stayed the course, and now I’ve quadrupled my original investment.

Jim: Splendid. But sometimes they don’t come back. Does the name Planet Hollywood mean anything to you? The point being, if you believe the company is solid, well-managed and still has a strong future, don’t sell until you need the cash. But if you’re unsure, well, you need some parameters.

Mike: Which reminds me of a famous quote by some long-dead financier--J.P. Morgan or Bernard Baruch, perhaps.

Jim: Go ahead.

Mike: An investor once told him that he had so much money in the market he had trouble sleeping at night. And the financier replied, “Then just sell down to the sleeping point.”

Jim: There’s also the famous line by another of those guys who said he never went broke selling too early. Look, my stance is pretty simple: Decide going in that, if the stock drops by 20% or 25%, you’re out. Take your loss and move on. Same on the upside. If you decide a stock is worth 25% or 30% above where it’s trading now, and it reaches your target, take your profit. It’s just good discipline and makes the decision that much easier.

Mike: Of course, if the stock is Qualcomm, that means you would have bought and sold it within the span of about four hours.

Jim: A planned approach also helps you sleep better. But there’s one caveat: Don’t look back.

Mike: Quoting Bob Dylan now? Or is it Satchel Paige?

Jim: If the stock goes back up after you sell for a loss, or goes higher after you sold for a profit, don’t beat yourself up. You stuck to your game plan, and that’s what counts.

Is It Too Late to Buy a Stock That’s Already Surged in Price?

Jim: I’d say history pretty well shows that this isn’t the case; the Dow Jones industrial average started the ‘90s at 2,750 and ended the decade at almost 11,500. But in terms of individual stocks, again I’d caution that we’re talking about buying quality, well-run companies here, companies with a solid future.

Mike: Even they are vulnerable at times. Remember October 1987? The blue-chip Dow industrials lost 23% in a single day.

Jim: And I’m barely going to address the skyrocketing Internet stocks, even though they cause lots of envy among investors who don’t own them. But there’s only a select few of those stocks that I’d even think about buying after their big gains.

Mike: Please don’t bring up Yahoo again.

Jim: Yahoo, for instance. Yes, I recommended it a few weeks ago at $170 and you, er, didn’t, Mike, and today it’s at $400. But that’s a rare exception.

Mike: Even among rock-solid companies, the market is littered with stocks that people once thought overpriced, yet kept soaring.

Jim: I have two examples to prove your point. One is Home Depot. Between 1995 and 1998, this stock almost quadrupled in price. One could easily have said, Shoot, how much higher can it go now? But you would have missed an additional 65% gain in 1999.

Mike: It’s pretty simple, really. Earnings drive stock prices. So the judgment you’re making is: Do I expect this company’s earnings to keep growing? If you do, then it’s usually not to late to buy the stock, if you have a long term view.

Jim: Precisely. Here’s my other example: Wal-Mart Stores. Between 1990 and 1998, Wal-Mart rose sevenfold. Too late to get in? The stock jumped 70% more in 1999 because its earnings kept growing sharply as well.

Mike: So does that mean you’d buy Qualcomm, the wireless-technology firm that started 1999 at $7 a share and ended above $176?

Jim: No, because Qualcomm doesn’t have a long-term history of steadily growing earnings and a steadily rising stock. Sure, in retrospect, if you’d bought it at $60 a share, it would have been a bargain. But Qualcomm, to me, is just a big-bang stock.

Mike: And not to cop out, but all this goes to one of the chestnuts of investment advice: Everything depends on your horizon. If you’re investing cash that you won’t touch for 10 or 15 years, there’s no point in waiting for a short-term correction in, say, General Electric or some other stock with a bright future.

Which Is a Better Strategy: Buy-and-Hold or Actively Trade?

Mike: Now, Jim, by sheer coincidence, I brought something along for this discussion.

Jim: What’s that?

Mike: My soapbox.

Jim: Uh-oh. Well, let’s hear it.

Mike: One of the more questionable trends in modern life today is the glorification of a trader’s mentality in stock investing. I’m not even talking about day traders.

Jim: In other words, buy-and-hold is old-fashioned, not hip.

Mike: We have no way of telling how many people out there are actively trading or standing pat. I suspect most are in the latter group. But all the hype and publicity surrounding the market for two years now has been aimed at the trader’s mentality.

Jim: Well, let’s be fair. If you want to buy a stock recommended, oh, say, in Stock Exchange, you have to make a trade.

Mike: That’s not what I mean. Let me give you a couple of examples. CNBC: You turn it on, and there’s that crawl of stock prices at the bottom of the screen, which suggests to people that they ought to be watching the prices of stocks, or worse, the moves in the Dow, minute by minute.

Or they feature the insights of somebody like Jim Cramer. Now Cramer is an entertaining guy. But what never seems to be disclosed is that Cramer heads a trading firm--he gets in and out of stocks on a minute-by-minute basis. So when he makes a judgment on a stock or the market, it’s a trader’s judgment. It’s not suitable, I’d say, for 95% of the investors out there.

Jim: I’ll give you another example. Just recently, some of the business press has been suggesting that maybe Warren Buffett--perhaps the best stock picker of our era, multibillionaire and a buy-and-hold advocate--is out of sync with today’s market because he’s had a bad year.

Mike: I’d love to be that out of sync.

Jim: But tell us exactly why active trading is so awful. Because, in one way it’s not as punitive as it used to be, now that trading fees are so low.

Mike: Sure, but now these online brokerages and other low-commission houses are clearly inspiring people to trade much more than before, which can quickly eat up your profits.

Jim: Of course they are. What would you expect?

Mike: Look, all this brings to mind one of my personal heroes, a famous blackjack card-counter named Kenny Uston. Uston at one point was a vice president of the Pacific Stock Exchange, but he threw that job over to count cards at casinos full-time.

Jim: Already I like him, too.

Mike: Anyway, he had a mathematically sound method of gambling based on what he called “the element of ruin”--what was the probability of his doubling his bankroll before a short-term swing wiped him out. The idea is you don’t want to wager so much per hand that some short-term losses leave you unable to play for the longer term.

The same goes for investing. You don’t want to plunge into, say, Internet stocks, that could quickly overturn before you can benefit from longer-term swings in stock prices.

Jim: Not only that, but to really profit from active trading takes a lot of time and energy. I mean, you have to watch your stocks very closely, because the pros certainly are.

Mike: Right. What those online brokerage ads show you are people trading at their desks, with doughnuts in their mouths, or they’re knitting while they write call options. Fact is, active trading is a full-time job, and most of us already have full-time jobs.

Is Foreign-Stock Investing Worth the Effort and Risk?

Jim: We’ve touched on this in past columns, Mike . . .

Mike: Yes, I remember, and so we’ll be parting company very shortly. As I recall, your basic stance on buying foreign stocks is: What the hell for?

Jim: That’s pretty close, though I’m not totally against the idea. But my basic issue, especially with emerging markets, is that buying those stocks presents the same problem we discussed in trying to time the market, only more so.

Mike: I hear you. And it’s true--very often, when you invest in foreign stocks, you assume not only the normal investment risk of any stock, you assume the risk that currency exchange rates will go against you at any time.

Jim: Not to mention political risk in a country.

Mike: Yeah, you wake up one morning and the tanks are in the streets of Moscow, which is something I’ve witnessed three times--though not as an investor.

Jim: You former foreign correspondents never tire of your war stories, do you?

Mike: And it’s true that the standards of corporate financial disclosure in many countries are far below those of the U.S. Now, that being said, not all foreign markets are created equal.

Jim: I’m not saying never buy a foreign stock. I mean, on these pages we’ve recommended a few, like the big Mexican phone company Telmex, and Check Point Software, the Israeli firm whose stock has been a home run.

Mike: And VimpelCom, the Russian wireless-phone company.

Jim: Don’t rub it in. And heck, Sony has finally wakened from the doldrums and its stock nearly quadrupled last year. But my point is, in so many foreign economies it’s hard to get a lock on when they’re recovering or when they’re imploding, because it happens so fast and their markets are so volatile.

Mike: But they provide needed diversification for your portfolio, plain and simple. Yes, these markets fluctuate, just as the U.S. market does. And if they fluctuate at different times, you’ve got some protection.

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Write or e-mail with a stock you would like to see discussed in this column. Peltz (james.peltz@latimes.com) covers the markets and corporate financial trends. Hiltzik (michael.hiltzik@latimes.com) covers technology and entertainment and is the author of the book “Dealers of Lightning: Xerox PARC and the Dawn of the Computer Age.” Either can also be reached at Business Section, Times Mirror Square, Los Angeles, CA 90053.

You can hear a preview of Peltz and Hiltzik’s weekly column Mondays on the KFWB-Los Angeles Times Noon Business Hour on KFWB-AM (980).