As the year began, it seemed like investors on Wall Street couldn’t have asked for a better start. The Dow Jones industrial average was routinely closing at record levels and the road ahead seemed smooth. But in late February, like a splash of cold water, a one-day drop in the Dow of more than 400 points reawakened complacent investors. It was the largest decline since the stock market reopened following 9-11, and it caused anxiety in some investors.
But Coy Satterfield, an education administrator in Atlanta, says he maintained his composure. Though he admits to being a bit alarmed upon first hearing the news, Satterfield calmed down after learning that the drop was in reaction to a decline in the Chinese market. “Considering the potential for volatility on any given day and how well the market had been doing lately,” he says, “[the market] was still a solid haven for investments.”
Satterfield, 56, says he’s learned over the years not to panic and to trust his instincts. Besides, the triggers to sell often seem clear. “It didn’t take a rocket scientist to see the handwriting on the wall,” says Satterfield of his stake in Delta Airlines. As an Atlanta resident, Satterfield had been a supporter of the locally-based airline, but he decided to sell four years ago after signs that the company “was clearly headed toward bankruptcy.” This included news of turmoil amongst the pilots, scrutiny of the airline’s pension plan, and an exodus of employees who were taking early retirement to avoid pay cuts. In the end, he sold his 30 shares at $45 a share, taking a loss of some $22 per share. In 2005, Delta declared bankruptcy and shares now trade for less than $1.
The message? There’s no magic in deciding when to sell a stock. You should closely track the companies you own, as well as their competitors. If the prospects have waned since you bought the stock, it’s time to cash in and look for a better investment.
“When you invest in individual stocks, they require close scrutiny,” says Richard Peace, an independent financial planner with Advantage Capital in Colorado Springs, Colorado, who advises Satterfield. “However, you should avoid the emotional roller coaster of the stock market.” All too often, investors chase returns and buy when stocks are high, then sell low at the earliest signs of a decline.
Mixed Signals
This month, Apple Inc. (AAPL), rolls out its highly anticipated iPhone. The company’s entry into the mobile phone market marks just one more step in its transition from a personal computer company to one of the country’s most successful retailers, a consumer electronics innovator, and an undeniable powerhouse in the music industry. Just three years ago the stock was trading near $14 a share, and in late March it closed at $93.52 a share–a 568% increase. But even such a dramatic climb in a relatively short period doesn’t mean there weren’t some potential sell signals along the way.
Last year, Apple ran into a few problems. There were rumors of product delays and it was one of the many companies caught up in a back-dating of stock option investigation. From mid-January to mid-July, the stock price was slashed by 41%–falling from $85.59 to $50.67. It was a six-month period fraught with signals for skittish investors to sell. Many lost sight of a long-term investing strategy and bailed out. However, in the end, CEO Steve Jobs was exonerated of any wrongdoing in the options investigation.
“A lot of people who bought at $63 last spring took a big haircut, and of course, the stock went on to trade at $97,” says Charles Payne, CEO and chief analyst of Wall Street Strategies Inc. in New York City. He reminds investors not to focus too much on the past. “For the most part, if the company is growing its business in a smart way and it’s been able to do that for a long time,” he says, “you have to believe that management isn’t going to make a big mistake. Mostly you’re betting on management.”
Have a Plan
Investors should set some guidelines when they buy a stock, advises Peace. “Just to give an example, you might tell yourself that you’ll look at the stock if it goes up by 25%,” he says. “On the other hand, you’ll re-evaluate after a 20% decline.” At those points, you can consider whether you still want to own that company.
“Suppose you bought a pharmaceutical company because it had a promising new drug,” says Peace. “Since you bought it, the drug did not pass a Food and Drug Administration review. Or maybe you bought a company that was No. 1 in its field but is now No. 2 after a merger of competitors. When events like that occur, you might decide that you no longer want to own the stock.”
Perhaps that former No. 1 company was bought at $60 a share and now sells for $75, giving you a 25% paper gain. At that price, given the new competitive situation, future upside seems limited, so you decide to sell. As Peace puts it, “Nobody goes broke taking a profit.” That’s especially true today, when the federal tax rate on long-term capital gains is capped at 15%.
You might think that the converse is true–nobody gets rich taking a loss–but selling at a 10% or a 20% loss can be a worthwhile move, particularly if it helps you avoid a loss of 50% or greater. What’s more, taking losses may offer tax advantages. “Especially when you are dealing with relatively small amounts, you should be confident that the amount of the loss will be enough to justify the transaction costs,” says Diahann Lassus, a certified public accountant and certified financial planner with Lassus Wherley, a wealth management firm in New Providence, New Jersey. Losses you
take can offset capital gains on other stocks, effectively making those profits tax-free. And $3,000 of net capital losses can be deducted from your other income each year, providing instant tax savings.In the end, stick to your plan and don’t be unduly swayed by overall market volatility. Like your decision to buy a stock, you should do a bit of homework when deciding to sell. So when bad news causes shares to drop, you’ll want to find out if anything fundamental has changed. If the business still seems strong and there’s a solid management team and strong earnings potential, you may want to hold on a bit longer.
Price Dip Sell signal or buying opportunity?
For the most part, you are going to avoid stocks that have been hammered if there are any of these accompanying factors:
Truly poor earnings results (the company’s earnings were either down or the pace of growth slowed considerably) and subpar guidance
A sharp reduction in earnings guidance between earnings reports
Massive departures of upper management
However, stocks could be buys if the downside driver was:
- A change in opinion by a Wall Street firm
- A negative mention in the media
- Geopolitical or topical news that doesn’t change the fundamentals of a company
source: Be Smart, Act Fast, Get Rich: Your Game Plan for Getting it Right in the Stock Market, by Charles Payne (John Wiley & Sons Inc.; $24.95)