tekboy: Re holding the good stuff if you chose well in the first place:
Talk : Communications : Qualcomm - Coming Into Buy Range
To: Ramsey Su (56553 )
From: Ruffian Thursday, Dec 23 1999 9:30PM ET
Reply # of 56595
FOOL ON THE HILL
An Investment Opinion
Bad Reasons to Sell
By Bill Mann (TMF Otter)
November 5, 1999
For this installment of the Fool on the Hill, I'm going to play lightning rod and put
forth a few highly controversial theories on portfolio management. These theories
are, by and large, completely in conflict with many of the most widely accepted
"truths" in personal financial management. You know what they are:
Don't let your portfolio become overweighted in one or two companies
Sell when a company becomes "overpriced"
Sell in advance of a potential market downturn
Sell after the stock just had a huge run-up
All of these rationales ignore a basic function of individual stock selection. That is,
a Foolish investor has gone through and tirelessly done research on the
fundamentals of the individual company, and has decided that it provides a
better-than-average chance for a superior return. Why in the world would the
same investor make sell decisions without re-examining the same criteria with
which he or she bought?
The answer is, they do it all the time. Heck, EVERY investor, at one point or
another, has faced one or more of the above fears.
I'm here to tell you that there have been more potential returns left on the table by
nervous investors following one of these sell edicts than there have been losses by
people who went over their holdings' fundamentals, decided to hold on, and were
wrong.
How much has been lost? In the words of Carl Sagan, "Billyuns and billyuns."
By following these "sell signals," an investor is actually adding additional risk to her
portfolio. Why? Because investing is all about maximizing returns over the long
term. In order to do so, investors must use certain things to their advantage, but all
of these things center on one single factor: knowledge. Knowledge of a company's
business, knowledge of financials, knowledge of the potential returns for the
company. By using external factors -- that are unknowable -- to determine
whether a company is ripe for sale, the investor gives away the one true advantage
that she has. That advantage is the knowledge of that individual company, what it
does, and how its economics work.
Already the hackles of the short-term traders are up. "What do you mean? You
don't look to see if a company is overbought? You don't care about the VIX, or
trend lines, or the 200-day moving average?" No, I don't. I don't use them
because I have never seen any concrete evidence that any McClellan Oscillator or
such has given anyone, ever, a better long-term advantage than good
old-fashioned knowledge.
The Fool on the Hill archives contain one of the best descriptions of investment
knowledge that I have ever read, written by Randy Befumo in 1997. It is titled
"When NOT to Invest" and remains a must-read for people looking to make their
fortune in the stock market.
Let's take a look at each of these portfolio management sell signals, and I'll try to
use a real-world example to show how strange the logic is when applied to other
situations.
By the way, I will repeat something I said in Wednesday's column. A quality of life
issue is ALWAYS a valid "sell" signal. If you've invested all your life and have
saved up and want to take some off the table, then go for it. If you can't sleep at
night because of nerves, or you don't want so much of your net worth tied up in a
single company, these are valid reasons to sell. They are even rational reasons to
sell. But they are also external to the fundamentals of a company and should be
recognized as such. Your state of mind has nothing to do with the performance of
a company or its share price. There is a big difference between rational decisions
and fundamental ones.
Reason 1: Don't let your portfolio become overweighted in one or two
companies
This can also manifest itself as a "diversification" argument. This may be the worst
rationale I know of for selling all or part of a winner, but it is also something that is
almost gospel in the brokerage and financial management industry. Why? The
thought that a company can make up 30%, 40%, or 50% of one's portfolio is
simple to look at as an undue risk. But let's look at a real-world application.
My colleague, David Braden, started this year (conveniently enough), with 10
stock holdings worth exactly $1000 apiece. One of those holdings is Qualcomm
(Nasdaq: QCOM), one of the true star performers of this year, the remainder of
David's holdings (again, conveniently enough) have exactly matched the
performance of the S&P.
By the way, I absolutely hate David for this, because last spring I spent a great
deal of time evaluating telecommunications technologies for a purchase I intended
to make. I really liked the CDMA technology that Qualcomm owned, but I didn't
feel that I had a good understanding of the overall marketability of it, so I went
with something I did understand: Iridium. Stupid, stupid, stupid.
So David's portfolio breaks down like this: As of today, he has $9000 in holdings
that have gained 10.85%, for $9976. He also has Qualcomm, which began the
year at $25 (yielding him 40 shares, split-adjusted). Each share is currently worth
$292, a gain of 1168% on the year. His Qualcomm holdings are now worth
$11,680, or 55% of his total portfolio. David's winner has run away from the rest
of his holdings. David's broker is telling him to sell some of his Qualcomm. But
why? Is the business case for Qualcomm worse than it was when David first did
his comprehensive analysis? No. In fact, David is more sure than ever what a
dominant technology CDMA will be. In other words, on the face of the
company's performance, there is no reason for David to sell it. Conversely, there
is still every reason in the world for me to still buy it, even though it mocks me so.
Reason 2: Sell when a company becomes "overpriced"
The simplest reply to this is "overpriced compared to what?" Stocks are still
valued upon their potential future earnings. If a company's future earning potential,
based upon your research, seems secure, then the concept of overpriced
becomes unsupportable. People have been calling Microsoft overpriced for years,
but its growth potential and net revenues in hindsight have supported its valuation.
Calling something "overpriced" means that you are claiming to know something
that is unknowable. We think we know about a company's future prospects, but
we should make our decisions based upon these rationales, and these alone. After
all, any good stock with exceptional growth potential deserves to be priced higher
than other, similar companies with lesser prospects.
Again, let's look at Qualcomm. If, last January, it was, by any estimation, 25%
overpriced compared to other similar companies, will that 25% matter two years
from now when the company's revenues have increased 10-fold? Probably not.
Reason 3: Sell in advance of a potential market downturn
Of the reasons to sell a company, this might be the worst, but it is also the one we
hear trumpeted the hardest on CNBC. It comes in several forms, including the
cycling of monies from one form of investment to another, as well as the "market
sentiment" that proves that things are moving lower (or higher).
More times than not, these market experts turn out, even over the short term, to
be wrong. How many times have you watched the market indices turn on a dime
in the midst of a trading day, with no underlying rationale for the shift. It happens,
really, on about a weekly basis. Think about it. We have seen some significant
gains this week in the stock market, but just three weeks ago you'd think that
investors had just seen their collective dogs being kicked. What changed? How
would one have been able to predict? Why was it that a prognosticator from
iTulip.com knew "with certainty" that October 19, 1999 was the date of the next
big crash?
The answer to each of these questions is somewhere. We just don't know where.
In the meantime, the market has shifted back into high gear, with such stodgy slow
movers as Berkshire Hathaway (NYSE: BRK.A) moving up more than 15% in
the process. Anyone who sold out in advance of the coming bear, for this and
countless other periods of time, missed the boat on a significant move in share
prices, but up, not down.
Let's go back to Qualcomm. Let's say my friend David sold it two weeks ago,
concerned that he was witnessing the beginning of a big drop in share prices.
Well, first of all, he sold at $230, meaning that he got to pay capital gains on his
shares, a gain of $8200. But also, he missed out on a move of some 30% as
Qualcomm proceeded to move through the roof. And for what? An external signal
that he could not predict accurately and misjudged entirely.
Reason 4: Sell after the stock has had a huge run-up
This argument is the same as saying that a company that has had a strong run has
likely used up most of its potential. This is market-timing at its worst. The thought
process is that the company has run up and so perhaps it would be better to go
and find something that has not gone up yet.
I'll use a simple, real-world analogy. Joe Single Dude has been on the dating
scene for a little while. He's been taking one particular woman out for a few
weeks, and he even thinks that he might really like her. They've had a great time,
they have a bunch in common, and well, things have progressed nicely.
What is the sane thing to do here? Well, according to the analogy, it's time to go
date someone else, someone like Scary Mary, who he took out one time but
didn't really have anything in common with. But in actuality, most people, most of
the time, are not going to act that way in a real-life scenario. Why do it in
investing? Why cut your best prospects off at the knees in order to go search for
something else? Is it rational to sell off a great company with outstanding
prospects (the only kind of company a Fool should invest in) to hope for the big
move from another company? Doesn't make much sense.
No, it is best to worry about your individual companies, and their prospects. Any
other factor is -- if past performance is any indicator of the future -- external,
unpredictable, and dangerous to the returns of the Foolish investor.
Keep on Foolin'.
My Pal Bruce. Thx. |
