Sale Stratigies
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"Nothing in the world can take the place of persistence.  Talent will not;  nothing is more common than unsuccessful men with talent.  Genius will not; un-rewarded genius is almost a proverb.  Education will not; the world is full of educated derelicts.  Persistence and determination alone are omnipotent."

Calvin Coolidge

Sale Strategies

The key to making money in the stock market for the great majority of us is to buy great companies or good mutual funds, preferably closer to market bottoms than market tops, continue to average in our savings at a regular basis, and to sit.  You bought these stocks for the long term right.  If you picked the right investments, chances are this is the right strategy.

Sitting is harder than it seems.  This strategy is more emotional than it seems at first glance.  A buy and hold strategy  is characterized mostly by inaction and boredom, punctuated by extreme elation at market tops, and depression and panic at market bottoms. 

There is no awards given for sitting out a bear market, but often this is just the right strategy.  First you and the market pundents will identify at least three bear markets for each bear market that will actually occur.  Then when you sell the stock you pay capital gain taxes and a brokers commission. If the bear market does not materialize and you repurchase the stock, you do not have as much money in your account, from the tax and commission bite, and the stock price is often times now higher than when you sold.  If the bear market really occurs and you can repurchase the share at a lower price, your stock must have fallen at least enough to make up for the tax and commissions on the sale and the purchase.  More often than not investors who are shaken out of their stock in a bear market often wait to long into the market recovery to repurchase their shares at a price that nets out the round trip purchase, sale, repurchase and tax consequences.  More often than not the investor would have been better off sitting.  Bernard Baruch summed up this subject with the advice: "Don't try to buy at the bottom and sell at the top.  This can't be done - except by liars."  Instead of getting caught up in the bear/bull worries by spectacular stocks.  You can make good profits over the short period by trading, but long term compounding of your capital at a high rate of return in great companies is where true wealth is made.  

Most investors see great stocks too soon.  Most investors feel great if they see a stock and lock in a one hundred percent return.  But consider any investor who locked in a one hundred percent return in Dell Computer in 1988.  He then would have watched the stock continue to grow at an annual rate of 79% for the next ten years.  His initial $1,000 investment would have grown to $351,356 at the end of 1998.  He made a good profit but he did not become rich.

A buy and hold strategy is the right strategy most of the time. This does not mean that you should not pay attention to your portfolio and prune investments when they do not meet your expectations or worse.  The key to a buy-and-hold  strategy is not doing anything, ever, but doing as little as possible with an occasional burst of activity hopefully at the right time, and for the right reasons. The fundamentals of an investment may deteriorate, or the fund manager you follow leaves or falls into a period of underperformance.  Other reasons to trim portfolios can come from the market itself .  Markets can reach extremes, bullish and bearish.  Benjamin Graham used an analogy - Imagine the stock market is a shopkeeper with violent mood swings.  When he is depressed he'll sell tomatoes for less than they are worth.  When he is exuberant, he'll demand more than they are worth.  The trick is to buy when Mr. Market is depressed, and sell when he is happy.  

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Factors to consider when selling a stock or a fund.

  • Losses.  A speculation you have made is not working out.  Great companies have remarkable recuperative powers.  Smaller or speculative stocks mort than often don't.  Admit mistakes early.  Everyone buys stocks in anticipation of a profit.  Define what your loss tolerance will be ahead of time.  If you made a mistake, admit it and move on.  Protect your investment capital.  Do not let your ego lock you into a losing position.  Maybe your stock will recover, maybe not.  If a stock drops fifty percent it must double just to break even.  Limit your losses to eight to twelve percent.  You can always buy your stock back later if it recovers, but more importantly you must protect your capital.
  • Earning deterioration.  In the long run the value of any good growth stock is its ability to produce superior earnings and profit margins.  If the company has a negative earning surprise, or its earnings or profitability  trend is slowing down, consider selling.  There are better places for your money.
  • Portfolio realignment.  Often we will experience a period of very good growth in one stock.  Growth that is disproportionate to our other core holdings and we may wish to sell some of our winners, to lock in some profits and rebalance your portfolio.   You Should consider trimming over time even your core positions in an extremely overvalued market.  You can never pick the top so consider dollar cost averaging out as you have dollar cost averaged in.  Replace your core positions over time when you think that the market has bottomed.  Remember no one rings a bell at the market top or bottom.  It is always safer to buy stocks in a rising market than to buy them in a declining market.  
  • Better opportunities elsewhere.  Consider the tax effects of the sale verses the upside potential.
  • Tax consequences.  Tax consequences of a sale, if you are trading in a taxable account, is always a factor.  There are tax consequences in every sale.  Consider a short term profit of $1,000 for an investor who pays a marginal tax rate of 39.6%.  The investor would pay $396 in tax leaving $604 to invest.  This $604 would then need to grow by 65.5% before they would break even. The investor will face new risks in the new opportunity and also a future tax consequence on this investment.  Tax consequences of a loss can help offset your gains. If your losses are greater than your gains, you can deduct up to $3,000  losses from this years income.  You must apply losses greater than that to future tax liabilities.  If you must sell a winner remember that long term capital gains (investments held for more than one-year) are taxed at only 20%.  If you believe that your stock is a looser you should sell, and sell early.  Consider matching losses with capital gains to offset the tax bite.  If the stock has potential, sell reluctantly. 

Tax consequences often have the greatest impact.  Markets can turn, earnings can improve, panics can turn into jubilation, but when a stock is sold the taxes on the profits are gone forever.  Of course tax consequences can be minimized in a tax deferred retirement account.  If you spend time to investigate investment opportunities that meet your own personal criteria, sell reluctantly, be aware, but not manipulated by the mood of the market.  There is nothing ennobling or character building about riding out a market sell-off.  Stocks don't know or care what you paid for them, the market is a mechanical entity.  Still money paid in tax is money lost forever.

Trough analysis for assessing a stocks downside valuation

You can get a good idea that a stock has reached its peak when analysis's ,who have been raising it's earning estimates, quarter after quarter, begin to issue cautions or even begin to cut estimates.  Just as most investors become overly optimistic in a bull market and project accelerating growth too far in the future, they also become overly pessimistic in a down market and project slowing growth too far in the future.  

One technique an investor can use to get an rough idea of how low a stock may trade is to use trough analysis.  Using this technique the investor takes the ten year historic low P/E and multiplies it by the current 12 - month trailing earnings of projected earnings.  An investor who purchases a stock at this price has a good chance of catching a very good entry point. 

This is just a price guideline and is based on the stocks price history.  If there is a very severe downside in the market, or the companies earning slide further than projected,  the bottom may well be lower than projected.  This technique works well with normal market corrections and does not work well if there are company specific internal problems that go beyond the market cycle.  Trough analysis works best with mature companies with relatively long histories and earnings predictability.

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