This excerpt is relevant to anyone considering buying efii at this time for long term.
Money in the Morning
Monday, December 22, 1997, 9:30 a.m.
What to do when a stock "blows up"
Shareholders of Shiva Corp. took it in the teeth
Wednesday, and many are left asking, "What now?"
by Michael Brush
(Originally appeared on Money.com on Jan. 9, 1997)
It's every high-flying tech stock owner's nightmare. One day you own a hot growth company whose business plan and product lineup hold great promise. The next day your stock has lost half its value and ripped a hole in your portfolio. In Wall
Street parlance, your stock has "blown up."
There may be lots of causes, but if you invest heavily in growth stocks, the likely culprit will be missed earnings expectations. And as Wall
Street moves into earnings reporting season now, expect to see more stocks blow up.
Watch out for the shrapnel.
Shareholders of Shiva Corp. (NASDAQ: SHVA), a company that produces devices offering remote access to computer networks, learned this the hard way Jan. 8 of this year, when their shares lost about 50% of their value. Just after the closing bell January 7, the company announced it would miss earnings estimates by a long shot because of weaker U.S. sales, delays in orders from IBM, and a sales growth lull caused by a transition to a new product line.
In a market where stocks get pummeled for coming in a few cents below Wall Street's expectations,
Shiva said it would be short big time -- estimating it would report between five and seven cents a share in earnings for the last quarter, compared to expectations of 21 cents a share.
The stock plummeted from a close of around $34
Tuesday to about $18, leaving shareholders -- not to mention value investors looking for good bargains -- asking a common earnings-season question: What do I do now? (Editor's note: Over the course of the year, other stocks suffered similar fates, including such name brands as
Oracle (NASDAQ:ORCL), Oxford Health Plans
(NASDAQ:OXHP) and Seagate (NYSE:SEG).)
To find out, we turned to the pros, who have lived through the experience hundreds of times. For them, the game plan to follow when a stock blows up is often easy. Almost too easy. Why? Most professional portfolio managers have a rigid set of criteria they follow in owning a stock. Once a stock no longer has the desired characteristics, out it goes.
"We have a very clear sell discipline," says Bill
Wykle, a portfolio manager with the Capital Small
Cap Growth fund, which gained 31% last year. "We are earnings per share driven. When we have an earnings shortfall, if the company came up short because of a revenue shortfall, that is a definite sell. If it is a one-time charge, then we keep it.
The only place where there is a gray area is if they missed by a penny or two."
This strict set of rules, in a sense, makes it easier for growth managers. So does the breadth of their holdings. With a hundred or so stocks in a portfolio, they can afford to jettison one quickly without thinking that much about it, since most of the other stocks are producing returns and serve as a cushion. In fact, that is exactly why they own a large number of stocks -- and why you should, too.
But many individual investors may not have the
$75,000 or so it takes to get good equity diversification. When one of their stocks blows up they may be more tempted to hang on for a recovery, since it was one of just a small handful. Should they? Here's what the pros say about making that decision.
First, of course, you should closely analyze the news that led to the earnings surprise. "You have to assess how comfortable you are with what the company is saying," says James "Chip" Roberts, the co-portfolio manager of the Oberweis Emerging
Growth fund, which was up 23.2% last year. "A lot depends on how familiar you are with the product line and how believable it is that it is a one time situation."
But when you analyze the news, don't be lulled by confident statements by senior managers that things are not as bad as they seem. Sure, they are under a strict legal requirement to tell the truth when publicly discussing news that could affect their company's share price. But a healthy does of skepticism is important. They may simply not know that more problems are on the way.
"I am a little cautious in looking at what management has to say," says Shannon Vanderhooft, a quantitative investor whose NI Growth Fund returned 11.3% since inception last May 31 until the end of 1996. "It is important to hear the company's explanation. But it is also important to hear an independent analysis. You want some corroboration that they are not living in a fantasy world."
After a disaster, Wykle expects results, not words. "My response is always: 'show me.' If they do, I'll be willing to take a look at the stock later in the year. In the meantime, I can find some other companies that are not having problems."
Look at analysts' earnings estimate revisions after the announcement. "If the analysts say the stock is fundamentally off, we try to be patient and see if the stock gains momentum," says
Roberts.
Don't be tempted to think that just because a stock is down, it is a buying opportunity. Wall
Street analysts have statistical evidence to back up what they call the "cockroach theory," which states that if you've seen one, there are more to follow. "Usually one earnings surprise is followed by another in the same direction," says
Vanderhooft. "But there are exceptions."
If you do move into a fallen angel as a value play, don't expect it to bounce back right away.
Usually a growth stock will take an initial big hit right after bad news is announced, because growth investors like Wykle get right out of a stock that no longer matches their criteria. But there is still likely to be lots of additional selling pressure from fund managers who want to wait to assess how bad the news really is.
Roberts, for example, will often close out half his position in a stock right away when bad news first hits. If the story continues to look bad or gets worse, he will try to sell the rest of the shares over the next two or three weeks. Other managers may just take a while to figure out how bad things really are. If no good news comes along in the weeks after the initial carnage, these managers are still in the market looking to ease out of their positions. That probably won't cause another big drop in value. Instead, it will keep downward pressure on the stock, even as new investors looking for a bargain come in.
Have a plan and stick with it. Even though you may be a small investor, you too should have an investing plan that you stick with, some managers say. "Retail investors should know why they bought the stock," says Wykle. "If it is not what they bought because of a change has occurred, they should take their lumps and move on."
Selling may also make sense because it frees up money for better investments, or because you will be able to use the capital gains loss for tax purposes.
"Nobody likes to take a loss, especially a large loss. But for the retail investor who is doing some tax management that is always a viable option," says Vanderhooft. "Typically a stock that has gone down so much isn't going to improve dramatically, so basically it is dead money. You can sell the stock and put the money into a more productive investment."
Editor's note. During the week of Dec. 22, we are featuring special "best of 1997" Money Dailies. We will resume current reports the week of Dec. 29.
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