Investors should Investing in stocks can be a marriage made in heaven.
know when to
head for the . . .
BRYANT FUKUTOMI / BFUKUTOMI@STARBULLETIN.COM
Overvaluation, changing
Portfolio manager takes peers to task
fundamentals and portfolio
risk are some red flags
for selling stocksBy Dave Segal
dsegal@starbulletin.comBut like any partnership, divorce sometimes may be a necessity if the relationship is no longer working out.
When Wall Street's last bull run ended in early 2000, investors who held onto their positions in the hope that the market would go even higher were trampled in a selloff equal in scope only to the astronomical rise that preceded it.
Selling may not always be easy, but consider this: the Dow Jones industrial average is off 15 percent from its all-time high of 11,722.98 on Jan. 14, 2000, the Standard & Poor's 500 index is down 24.7 percent from its peak of 1,527.46 on March 24, 2000 and the technology-heavy Nasdaq composite index has plunged 62.3 percent from its nosebleed level of 5,048.62 on March 10, 2000.
In many cases, investors who bought near the top are drowning in red ink while long-term buy-and-hold proponents likely have seen a big bite taken out of their profits.
Perhaps Richard Behnke, owner of broker-dealer Abel-Behnke Corp. Securities in Honolulu, sums up the art of selling best with this borrowed quote from a prominent French financier:
"Going back to Baron Rothschild, when asked how he became a billionaire, he said by selling too soon."
Of course, investors often don't know ahead of time if a situation will occur when they have to sell a stock. But as long as they or a financial adviser regularly monitor their portfolio and have an exit strategy in place, investors won't have to watch a big gain evaporate or a loss reach unbearable proportions.
"The reason for buying a stock is that you're anticipating profits, and that's a positive emotional response," said Harlan J. Cadinha, chairman and chief executive of Honolulu-based broker Cadinha & Co. "When you sell a stock, you're doing it because you felt some pain or are anticipating some pain or looking at paying taxes. Selling connotes a negative emotion of sorts, and that's why it's probably easier to buy than sell."
Counting dividends, stocks have historically returned an average of about 11 percent annually over the past 75 years -- a return most investors would gladly take these days. But that yield refers to the overall market and also includes negative returns. During some decades the returns have exceeded 18 percent a year while in other decades the stock market has provided less than 5 percent a year. Such periods of poor performance are usually accompanied by extremely high valuations at the beginning of those periods.
"In general, there are two main reasons to sell a stock when managing a portfolio," said portfolio manager Barry Hyman, a vice president in the Wailuku, Maui, office of Suttons Bay, Mich.-based Financial & Investment Management Group Ltd. "The most common reason is when the valuation of an investment is no longer compelling, you sell it. The second reason is when you own an investment that still has some upside, but another investment out there is more compelling, sometimes you sell one security to replace it with another.
"If you buy a great company at a great price and the price runs up to the point where it's fully valued, or worse, overvalued but it's still a great company, too many investors -- which include many professionals out there -- are stuck on the idea of hanging onto an investment for one or two reasons: One, they still think it's a great company so why sell it or two, because they're fearful of paying capital gains taxes on that investment. But those are terrible reasons to hold onto an overvalued investment. A buy-and-hold-at-any-price strategy is lazy, irresponsible and foolish if it means holding onto investments well in excess of their true value."
And what makes a stock's price compelling? Hyman defers answering that question to legendary value investor Benjamin Graham, who Hyman said outlined in his 1930s text securities analysis some rules of thumb for valuations.
"You generally want to own companies whose prices are low relative to their annual revenues, whose prices are low relative to their book value (worth of the company), whose prices are low relative to their annual positive cash flow and whose debt is low relative to their capital structure (a combination of a company's cash, debt and other assets and liabilities)," Hyman said.
Clearly, then, investors have to do their own homework or, if needed, find a financial adviser or fund manager that they trust will have the investor's best interests in mind.
"There's no cookbook for this stuff," Behnke said. "There's no substitute for thought and analysis. There's nothing you can write down on a couple pages that will work in a volatile and changing market."
And don't expect to get rich overnight, he added.
"Trading short term is a losing strategy over the long run," Behnke said. "If you're not prepared to hold a stock for three or more years, you shouldn't buy it. But that doesn't mean you never sell it.
"By and large, people trade too much. They don't hold stocks long enough, but that's an average statement. It seems better to me for people to buy five or 10 stocks and focus on those five or 10. Maybe that would account for 70 percent of one's portfolio and be long term, and you're also deferring both commissions and taxes. The smaller part of one's portfolio, maybe 30 percent but that number isn't rigid, can be trading vehicles."
Behnke said there are several proven strategies for stock investing, including one that involves gradually building a position and not selling or buying all the shares of a particular stock on one day.
"If you can think of a pyramid, or an inverted pyramid in the case of selling, start selling a stock at a certain price and if it goes higher, sell more. On the bottom side it's a regular pyramid, and if the stock goes down, you buy more. Basically, you sell more at a higher price if you think of an inverted pyramid and not selling all at one price. When you buy, instead of buying equal amounts as it goes down, like in dollar-cost averaging, you buy more as it gets cheaper."
Cadinha advises investors to re-examine one's vows before staying married to a stock.
"When a company fails to deliver the promise in which you bought the stock, you have to get away from it," he said. "If you bought a stock and hoped it would grow 20 percent a year, one shouldn't be swept up by the little ups and downs. Our view is to look at the big picture.
"I don't use stop-loss orders in a client's portfolio. I hold onto the view that you're not buying a stock but buying a business. You're investing in a company rather then trading on price movement. If the business delivers what's expected, then ultimately you'll meet success along the way.
"We're not traders. Definitely let your winners run -- even if they've had a big move. If you're fortunate enough to have a company that has delivered fundamentally and that business is indeed growing, by all means stay with it. That's how fortunes have been made in the Wal-Marts, Intels and Microsofts over the years."
Cindi John, an Edward Jones investment representative who gives free weekly seminars at her South King Street office, said there's a litany of reasons that investors should consider in selling stocks.
"The first thing I do is look at the fundamentals," she said. "And the fundamentals include things like earnings. Are they consistent? Is the company going to have a catalyst for continued growth? You look at sales growth, pretax margins, levels of inventory."
Other reasons to sell a stock, she said, are to improve the quality of a portfolio, to reduce risk if a stock takes over more than 20 percent of one's holdings, if the portfolio is too overweighted in an industry such as technology, if it makes financial sense -- after checking with your accountant -- to take a tax deduction, if the investor made a mistake buying the stock in the first place and if the company's price-earnings ratio is extremely overvalued than is normal for the stock or industry.
"You shouldn't just sell a stock because the market is going down," John said. "You need to look at the fundamentals to see if the story has changed for the company or if you've lost faith in the integrity of the management. Basically, what I advise people is to look at the reasons they bought the stock in the first place and would they still buy the stock today."
Portfolio manager Barry Hyman, a proponent of value investing, said some fund mana- gers and financial advisers have been doing a disservice to their clients in simply trying to keep up with the crowd. Portfolio manager
By Dave Segal
takes peers to task
dsegal@starbulletin.comHyman, a vice president for Financial & Investment Management Group Ltd. in Wailuku Maui, said money watchers have a responsibility to dig further into a company's numbers.
"The individual investor doesn't have a lot of this information at his disposal so the typical investor farms it off to a professional," Hyman said. "The thing that seems so crazy is it's as if those professionals aren't looking at basic, common sense valuation measures, either.
Hyman recounted a situation on Maui last week in which a financial planner was questioned why he had bought Standard & Poor's 500 index funds for his clients in 1998, 1999 and 2000.
"The answer was 'because of the risk,' " Hyman said. "When the line of questioning continued, (the financial planner) said the 'risk' was the risk of losing the client if the S&P 500 continued to rise."
Hyman said "there seems to be little concern as to whether the risk of losing money is appropriate for the client.
"That mentality is pervasive on Wall Street and among mutual fund managers, partly because they're compensated based on how well they do vs. an index or a benchmark. If you beat your benchmark, you get a huge bonus ... So if the index drops 40 percent and you lose only 35 percent of your client's money, have you done well for your client? Apparently the mutual fund industry thinks the answer to that question is 'yes.' "
