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Published by: Lyon Capital Management, LLC - A Registered Investment
Advisor
24B Grove Street * Pittsford, NY 14534 * Tel: 585-248-9821 *
www.lyoncapital.com
The Art of Selling a Stock
By Doug Lyon, CFA
When most people think of investing they think of buying a stock or bond.
But buying is only half the equation. Knowing when to sell an asset is just
as important. And often it is a more complex decision.
When most investment advisors discuss their investment style they speak only of what
method they use to select a stock for purchase. In this article we’d like to
elaborate on the method we use to determine when to sell a stock.
Selling on The Up-side
The parameters of the “sell discipline,” as it is sometimes called, begins
with establishing goals for what we expect a stock to do. When we first purchase a
stock we have a goal for the up-side of the investment. To put this in more concrete
terms: The upside goal is to reap a gain of 50% over three years, which is a 15%
annual return plus any dividends. When the stock reaches the up-side goal we often take
profits by selling some or all of the position. If the stock appears to have strong
fundamentals and continued strong growth potential, we will continue to hold a portion.
Selling on the Down-side
We also have an idea for how low we think the value of the investment could possibly
go. We recognize that stocks don’t always go up, even when we have done our
best to select investments we think will increase in value. When a stock goes down
more than 20% from the original purchase price then we re-evaluate the investment.
One may ask,“Why 20%?” Simply put sometimes out-of-favor stocks (the
type of stocks Lyon Capital Management buys) go down before they head back up.
Unlike growth investors we are not buying stocks already on the rise (usually more
expensive) and selling at the first sign of bad news. Often the companies we buy may
go lower because of recent bad news or market trends. In addition, in today’s more
volatile market it is not unusual to see large swings in the value of a stock. A
stock may rapidly go down 5,10, even 15% and then quickly rebound. If one has a
discipline to always sell when a stock is down, say 10%, one may miss out on an
opportunity and incur an unnecessary loss.
A decision to sell is based on how the company is performing. We ask questions
such as: Is management following through on their stated initiatives such as cutting
costs, selling off under-performing divisions, or expanding in new markets? Is the
company’s debt level falling? Are margins improving? If the answer to any of
these questions is, “ No,” we re-evaluate whether
or not we should continue to hold the investment and we may sell. It is important to
exit a position when one has lost faith in an investment.
Buying on the Down-side
If, however, the reasons we bought the stock in the first place are still in place, a
lowered price is an opportunity to buy more. And often that is what we do. If
we have strong confidence in the stock, even after a 20% drop, we’ll purchase more.
Tricks of the Trade
To hedge when we first start investing, we sometimes buy a small position. The
idea is to begin small and then add to the position as the price goes down. When we
buy we try to do so at what we believe is the lowest price; however, buying at the lowest
possible price is almost impossible and is almost a matter of luck. So when we buy
at what we think is a good price we are fully prepared for the price to go lower, to take
advantage and buy some more. The bane of buying undervalued out-of-favor stocks is
that they can become more out-of-favor (meaning the price goes lower) before the value is
realized by the marketplace and the price goes up. The reward is buying quality
companies at bargain prices and earning good returns on investments while taking
below-average risks. It is a strategy that may not be as glamorous as buying a
stock when it is on the rise, but it certainly carries less risk. And for
conservative, patient, long-term investors it is a more desirable, and often more
rewarding strategy.$$
How
Have They Done? |
Stock |
12/31/99 |
9/15/00 |
% Change |
| AOL |
76 |
55 |
-28% |
| Qualcom |
176 |
66 |
-63% |
| Worldcom |
53 |
29 |
-45% |
| Amazon |
76 |
44 |
-42% |
| Home Properties |
27 |
30 |
+11% |
| Emerson Electric |
57 |
65 |
+14% |
| Waste Management |
17 |
19.5 |
+15% |
| Dow Jones Ind. Avg. |
11,500 |
10,927 |
-5% |
| NASDAQ |
4,070 |
3,835 |
-6% |
S&P's A+
Equity Rankings
by Doug Lyon, CFA
Standard & Poor’s is an independent rating agency well known for its rating of
fixed income securities (bonds). But Standard & Poor’s also rates and ranks
common stocks. Investors are familiar with Morningstar ratings or Valueline ratings,
but Standard & Poor’s long standing assessment of common stocks is sometimes
overlooked…but not by us!
Fixed Income Ratings
A Standard & Poor’s (S&P) rating is like a seal of approval for a fixed
income security. Sale of a fixed income security without an S&P rating is
difficult. The rating is an assessment of the capacity and willingness of an issuer
to make periodic interest payments and to repay principle.
Equity Security Rankings
S&P’s rankings for common stocks range from A+ (highest) to D (lowest).
The rankings are determined based on a company’s per-share earnings and dividend
records for the most recent ten years. Advantages of a company’s size from an
investment standpoint are also recognized. S&P points out that rankings are not
a forecast of future market performance but merely an appraisal of past performance.
As we all know past performance is no guarantee of future results.
Having said that, a high ranking indicates to us that a company has built an advantage
in the marketplace that has been rewarding in the past and is likely to be rewarding in
the future. If the business is not becoming obsolete and the company’s stock is
not over priced, we believe that top ranked companies by S&P make good investments.
Ben Graham, the father of modern security analysis, recommended the intelligent
investor have A+ rated securities represented in a portion of his or her
portfolio. He believed that during market downturns these types of stocks hold up
better than more speculative issues. Speculative issues tend to do well when the
market is strong but fall sharply (as we have seen so far this year) when the market is
weak.
S&P ranks over 5,000 common stocks and at last count roughly 70 of those were
ranked A+. You might be surprised to learn that market darlings like Intel, Cisco,
Oracle, or Corning are not ranked A+ by S&P. The reason for this is that they
have too short an operating history or too volatile an operating history or both.
Examples of A+ ranked companies are Abbott Labs, General Electric, Merck, Wal Mart,
Genuine Parts, Emerson Electric and UST.
An A+ Strategy
Lyon Capital Management clients own several A+ companies. We believe a weighting
equal to 20 or 30% of total stock holdings (or 4 to 6 different issues) is a good target
for most portfolios. This gives a good exposure to some of the world’s top
quality companies. And, it provides good diversification for a portfolio that also
contains other types of securities. If you have an interest in the S&P ratings
and how we apply them to an overall investing strategy, give us a call. We’re
happy to talk it over with you. $$
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