In a comment to my blog about dueling picks on AOB that both turned out positive, fellow Fool Capsperson asked me how I went about ending under perform picks. The reply got pretty long so I decided to duplicate it as its own blog entry.
For starters, I'm not sure I'm the best person to ask for advice on ending an underperform. AOB is one of the rare cases where I got lucky and pretty well nailed it. Most of the time I end picks (both directions) too early and leave points on the table.
As a general rule, you would end the underperform when the situation that made you think the stock was overvalued isn't valid any longer and the stock is approaching fair value. Easier said than done.
In the case of AOB, I really didn't know much about the company other than what was in the Barron's article and a quick glance at the Yahoo Key Stats. The fundamentals actually looked pretty good on it, so when I had a chance to end the pick in the green, I jumped on it.
Some other examples of recently ended picks and my thinking behind them. IBCIQ.PK, Interstate Bakeries. I still think this company is going to zero - but, they have some very well known brands like Twinkies, Wonder, Dolly Madison, so when the pick was ahead by 15 pts, I ended the pick to protect against the possibilty, if unlikely, that someone might buy the company to get the brands. As of today, I left a lot of points on the table with this one and it's now below CAPS $100 mil threshold.
For a more relevant example, Rubio's - I've followed this stock for awhile and even owned it earlier this year. It made a rapid climb when it crossed the $100 million market cap threshold and it just looked too far too fast so I red thumbed it. It fell, I ended the pick, it bounced and still looked over done so I red thumbed it again. It fell, I ended the pick. Then it consolidated for awhile, and I gave it a green thumb. I don't have a good grasp on technical analysis, but that's pretty close to what I did with RUBO - I red thumbed it when the price looked too high compared to the recent trading range and valuations, ended the underperforms as the stock came down to values within it's recent range. The outperform pick was a combination of the stock coming back to the low end of its range, coming down to a more reasonable fundamental valuation, and that I like the potential for this becoming a regional to national growth story.
In the rare cases where I trade for real like the RUBO description, I'll trade around a position - either go slightly overweight when it looks cheap and sell back to a neutral weighting as the price goes up or sell to under weight when it looks expensive and buy back to neutral as the price comes down.
Hope that's helpful. I think the most difficult part of an investment, either real or in CAPS, is knowing when to end it. Based on the number of points I've left on the table, it's an area where I would really like to improve.
Please feel free to chime in with your decison process for ending picks or examples of how you end picks. This could be interesting.