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Ending Underperforms

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August 30, 2007 – Comments (7)

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.

7 Comments – Post Your Own

#1) On August 30, 2007 at 10:37 PM, Capsperson wrote:

Thanks for the detail on my question.  It does give me a perspective that I didn't have.  When I have ended a pick, I'm not paying a lot of attention to it and I should and will.  Thanks.

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#2) On August 31, 2007 at 1:57 AM, StockSpreadsheet (74.73) wrote:

My process for ending a pick would be based on one of two factors:

1)  I get some new information about a company that would have made me decide to not buy it in the first place.  This could be based on restated earnings, hidden losses, (a la Enron and its off-balance-sheet entities), or any number of other factors that would figure into my decision-making process.

2)  The company exceeds my target price.  On every pick I make, I have a target of where I think this stock could be in five years based on its growth rates, its earnings and on its industry.  (You will see target prices on all of my stock pitches.)  If the stock price gets very close to what I think its fair value is, and especially if its valuation is above that of its industry, I will reevaluate it.  If I don't come up with a new higher target price, I will think the stock is fully valued and will end the pick in CAPS, figuring that I have lots of other ideas that I consider undervalued and would therefore be better performers for me.

In the real world, I might hold on to a stock that I considered fully valued if I still think that it has room for future appreciation, since I don't want to pay the taxes on selling a stock if I still think it has room to run and if I still think it is a good stock.  This is true even though I might have other ideas that might be better, since the current stock is a proven performer and my other idea may not turn out to be a good performer, (witness my current accuracy rating in CAPS, though this is on a very short time basis and my real-world performance is much better on a total basis, and I am beating the S&P performance over a 5 year period last time I checked, (a few months ago)).  

Anyway, that is my philosophy.  I hold stocks for the long term, and all of my real-world holdings I have had for at least 3 years, so I don't trade much.  Hope this helps.  Take care and have a nice day.

Craig 

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#3) On August 31, 2007 at 2:14 AM, JASCruz (97.89) wrote:

I agree, ending a pick is one of the hardest things--especially once I've gotten attached to and have been really rooting for a stock. It sounds like you generally trade in and out of positions a lot more than I do, so maybe you're looking for different things than I would. I'm more of a LTBH kind of guy. Still, it's helpful to know what signals would indicate "Sell" (or "Buy back" for short sales).

Since I'm mostly a long-term investor, I'm looking at the fundamentals and the story of the stock. I'll buy a stock when I like the story, the fundamentals and the price. I'll sell when the story or the fundamentals falls apart--I'm not so good at selling on price alone, but I have an idea below.

A good example for me is NFLX. I bought it in summer 06 because I liked the story--fast growth, revolutionary idea, personally loved and used the product, and still do. The fundamentals were sweet--highly positive free cash flow, no debt, growing. My valuation calculations suggested it was undervalued. When the price crashed after an earnings announcement that summer, I bought, dreaming of the best.

Well, most of us know the story from there. Blockbuster has put up a hell of a fight, and Netflix stopped growing, in terms of customers. I didn't like the story anymore. They still have great fundamentals, as they are still profitable and still have no debt, but the growth is currently gone. I sold NFLX early this year for a decent profit, and was relieved that I had done so when I saw it crashed hard again after its latest earnings, and hasn't really recovered.

I don't always know when to sell, but I realized that I could see a sell signal in NFLX because I understood the business. I was a customer of the product, and they have a very simple business model. I don't have the same ability to see those sell signals in semiconductor or biotech stocks.

As for selling when the price is high, it sounds like that's working for you. It makes sense that if I wait for the price to go down until it's undervalued to buy, then I would sell when the price has gone up to overvalued. If I had, I would have made a decent profit on LOOP and SNHY, selling at least part of them as they soared before they crashed back down. Still, I believe in their fundamentals, and believe that they will go up lots over the long-term.

My dad sells off half of his shares of a company after it doubles, ensuring that he gets his original investment back. That doesn't always work for me, unless the stock price doubled far faster than my estimate of actual value of the company. It just seems to limit upside growth and ignores the "story" part of the equation. Still, it's one way of taking the emotion out of the selling process, and it has clearly worked for him.

Thanks for starting the discussion; it's fun sharing my ideas (and I came up with some new ones while writing it!)

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#4) On September 03, 2007 at 11:55 AM, rd80 (98.66) wrote:

Caps, Craig and Joel - Thanks for contributing to the discussion!

Have a great week, Russ 

 

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#5) On September 03, 2007 at 5:05 PM, SidBord (30.01) wrote:

<>I'm a short termer (too impatient for the long term).  I've done very well in actual buying and selling doing pretty much what rd80 does.   I start out with a target of at least 6% to 7% increase (I never short) hopefully within the next month or two.   I look at the price charts that I maintain to help me decide if I think the stock is going to move in the up direction soon.  I put less value on "stories" and I don't really care too much what the business is.  All that really counts is what is going on in recent history (3 to 6 months) and REAL recent history (2 to 4 weeks). 

I plot the Bolinger bands on my price charts to help me guess how far up from now the price is likely to go before stumbling.  If it looks like it can go 6% to 7% (and hopefully more), then I'm likely to take the plunge.  The Bolinger bands also help me decide when the price will start turning around at the bottom.   I also plot the RSI (Relative Strength Indicator), which gives clues about when a stock is oversold and ready to turn up. 

For a better understanding of what common patterns of stock prices mean , I strongly recommend a book named "Technical Analysis of Stock Trends" by  Edwards and Magee.  SInce it's expensive to buy, you might want to look for it at your local library.   It's remarkably helpful in making decisions.

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#6) On September 04, 2007 at 10:58 AM, rd80 (98.66) wrote:

Sid - Thanks for the comment and the reference recommendation. 

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#7) On September 04, 2007 at 1:32 PM, JASCruz (97.89) wrote:

Hi Sid,

How is that working for you? Have you been doing it successfully for a while? Are you making enough money following this plan to make the effort worth it (including ST capital gains and commissions)? After all, buying a bunch of shares of SPY and sitting back and waiting is really easy...

Thanks,

Joel

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