October 18th, 2010

It’s Time to Clean House

If you buy into the notion that the market is really going to take off in 2011 and you have most of your cash invested then you probably already have stocks with 20-30% profits. The question your probably asking yourself is “When should I sell?”

I just had that conversation with my wife. She subscribes to an investment service that tells her to sell half a position that’s met its price objective so she can then play with the houses money. The only problem is that she then takes those profits and gambles them on another stock … which may wind up performing only half as well as the stock that she was instructed to sell. (I offer her a “friends and family” subscription to my Alerts service but she’d rather pay good cash for some big name service that’s more expensive and gives her bad advice. I just don’t get it ….?). Rather than thinking about when to sell those great stocks and lock in some profits, perhaps the time would be better spent on the stocks that under perform.

As subscribers to Alerts know, there are now 69 stocks in the model portfolio which was launched at the end of March (that model portfolio replicates my personal portfolio except that amounts and quantity of shares for each position are different to maintain confidentiality). Nearly 80% (precisely 59) of those stocks now have a profit, nearly 40% show profits of 10% or more and 16% have profits of 20% or more.

What should I do? If I sold half the position on those 20% gainers and reinvested, I’d increase the number of stocks I have to watch from 70 to close to a hundred. If I kept subdividing in half each time a winning position had a 25% profit, I could wind up in a year with a portfolio that challenged the S&P 500 in depth and breadth. Why not just buy an Index ETF at the outset and just forget about picking individual stocks.

Here’s something to keep in mind: three factors contribute to a stock’s price movement:

But these three factors don’t influence equally. The largest single contributing factor is the market itself, then the industry group and, finally, there are factors unique to the company itself and its stock. If all of the stocks that are up more than 20% are tech stocks then I would be foolish selling half of those because 70% of the reason these are up is because most tech stocks have been in demand and the market in general is up. It would be sort of ridiculous if I sold half of the position and bought some other tech stocks just because, right now, tech stocks were doing well?

There is something you can do, though, to prepare the prospect of a rising market lifting most stocks. Look at the stocks that aren’t doing well or under performing (yes, we all have them). Try to determine if the reason they’re not doing well is because of their industry or something to do specifically with the company; you can’t blame the market because it’s now doing fairly well. If you’re going to sell anything then it should be these stocks so you can redeploy that money to better performing stocks.

Not only do fundamental financial factors contribute to a stocks price performance, but each has its own “personality” resulting from the unique supply and demand situation of its stock. Is it closely held? is it actively traded? is there a large short position? is there a large institutional following? is it an IBD favorite? is the company acquiring it’s own shares? etc., etc.

There are too many variables to sort out individually but you can calculate it’s relative performance, the amount of change in the stock’s price since August 31, for example. That date’s the bottom of the right shoulder of the inverted head and shoulders patter, when the market began it’s climb across the neckline to a 12.5% increase to date. How have the stocks you’ve owned performed? Will the stocks that have appreciated, say, only 5% catch up or will they forever be laggards? What about those that have declined?

It’s not to say that you have to dump them? But you should have some really good stock supply and demand or Industry Group reasons for keep them in your portfolio. Now’s the time to start preparing for 2011 by cleaning house and replacing the laggards and losers with some higher charged stocks.

Subscribe below or click here to learn more about help for navigating turbulent markets.