Ted Allrich is the founder of The Online Investor and author of the just released book: Comfort Zone Investing: Build Wealth And Sleep Well At Night. In this weekly column, he'll offer advice to investors who are just getting started.
"As soon as I break even, I'm getting out of this dog."
How often have you said that about a stock? It's one of the biggest mistakes an investor can make.
Stocks go up and down. They don't care where you bought them or where you sell them. They move on information, unaware of the pain or joy they cause you or other investors. What you need to focus on is why you own it and what is happening since you bought it.
Let's take the last first. The reason you bought it was for some specific set of events or an event. For example, if earnings have been ramping steadily for several quarters, analysts may be predicting an even faster increase in the future. You bought it with the expectation of better earnings. If the stock didn't deliver those earnings, then it will be lower than where you bought it. So you need to decide if it was a one time event or more trouble lies ahead.
The best sources to find out about earnings are the company release of its quarterly results and analysts opinions. The company will point out the shortfalls and explain why earnings were light. Maybe a large order was delayed, pushed into the next quarter, as is often the case in software sales. Maybe earnings were hit with a one time expense such as a division closing that was losing money. These are understandable and short term in nature. They shouldn't affect the stock price by much. It's the underlying, ongoing business that's important. If operating income is still growing, then you're fine.
If, however, operating income is slowing because customers aren't buying, then it's another, more sinister event. Maybe there's a new product out that's better and cheaper than the one your company makes. Or maybe costs for materials has risen and gross margins are compressing. Both of these could be ongoing problems, not easily resolved. In the case of raw materials, that's not even in the control of the company. Then you'd have to question why you would still own the stock.
Or if there is catastrophic news such as accounting fraud or several executives leaving at once, then you really have to question why you would continue to own the stock. In the former case, it usually takes years to overcome the stigma of accounting fraud (not just errors but premeditated "errors"). If several executives resign, you'll need to find out why. Both of these event almost always require selling the stock in order to buy others that don't have these problems.
Simply focusing on where you buy a stock and hoping for the best doesn't cut it in investing. You need to re-evaluate why you own it and why you should keep it, not how much you've lost or made. Remember there are plenty of other stocks in the market that give good returns. If you hang on to your losers too long, not only have you lost money from that investment, you've foregone the returns from other, better stocks.
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Reader Comments (Page 1 of 1)
9-08-2007 @ 12:46PM
bobsadviceforstocks said...
Ted has written another outstanding column on Blogging Stocks! As an amateur investor, I also struggle with the "whats" and "whens". What should I be buying? What should I be selling? And when should I be doing this?
There are multiple factors that enter into the decision to do something in the market. Certainly deciding which stocks to own is critical. I choose to look at growth prospects believing that a company which can grow earnings and revenue consistently will likely have a bright future. I do this from my own experience in observing the greatest movers in the market like Rubbermaid, Wal-Mart, McDonald's or even Microsoft which cranked out earnings growth quarter after quarter and year after year and I observed how these stocks grew over the long haul. Reading William O'Neil and "How to Make Money In Stocks" reinforced my own bias and I started to working out some of my own strategies for identifying potential 'winners'.
Other investors believe in searching for value in the market, looking for stocks that should, according to them, be selling at a higher price, if investors only understood the 'worthiness' of the equity. They are looking for companies that have been somehow overlooked by the investment world and based on other criteria such as 'book value', 'price/sales', or 'price/earnings' ratios, believe that eventually the stock prices will rise to a more reasonable valuation without necessarily considering the future growth prospects at all.
Finally, perhaps the wisest group of investors looks at a mix of all the strategies. They are sometimes referred to the GARP investors who wish to pursue growth but at a reasonable price. They examine the PEG ratios and compare valuation numbers to expected growth in the underlying statistics. They look to find the best of both worlds. Why not look for everything in an investment?
In regards to selling, from my perspective, if one simply looks after each individual stock within one's portfolio, then the management of the entire portfolio will follow. In other words, instead of trying to guess the future direction of the stock market, I have found it most prudent to monitor each stock that I own, limiting losses on the downside to pre-set levels, and taking small gains as the stock move higher in price.
I do not think it is wise to 'fight the market' or to fail to understand the market direction. But I haven't found it necessary to do much 'thinking' or anticipating the direction of future trading activity. Instead, like Allrich suggests, I monitor the fundamentals and watch the stock price to make sure that my stocks are not creating endless losses for me.
Furthermore, instead of trying to guess the market future, I allow my own equities to generate signals that let me know that it is either time to increase exposure to stocks by adding a new position, or to move towards cash by not reinvesting proceeds. I do this simply by using the two metrics of sales either at appreciation levels (a positive signal), or sales on downward moves (a negative signal). I try to keep things simple so that I can respond, albeit somewhat with a lag, to market action.
Like Allrich, I do not rely on "hope" or ignoring news. But instead of anticipating things, I let my own stocks and the fundamentals determine my trades.
You are all more than welcome to visit my blog and comment there as well. I am an amateur and am still working at figuring out all of this!
Bob Freedland
Stock Picks Bob's Advice
(http://bobsadviceforstocks.tripod.com/bobsadviceforstocks/)