Buying a Stock: Step 5 – Monitoring your Stock
Portfolio Management consists of two simple tasks: Defense and Offense. Defense is critical and involves just what you might expect it to: protection from harm, prevention of loss.
Offense is less urgent but involves optimizing your portfolio’s performance by replacing companies whose potential return has declined, with new, high-quality companies with a better potential for return.
For every five stocks you buy, one will do better than you expected, three will do about as well as you expected, and one is going to tank. Defense means simply watching for that one out of five that will do poorly, replacing it as soon as you’re sure it’s not going to be able to continue to grow as you had expected it to. So don’t worry if all of your stocks don’t do well.
Our new company, FactSet Research, ends its fiscal year on the last day of August each year. Counting the time it takes following the closing of the books for the data to become available (105 days for the annual and 60 days for the quarterly data), you will need to pull up FactSet in StockCentral’s Take $tock only four times during the year: on December 15th, and the first of February, May, and August to make sure it’s still reasonably good enough to buy, and therefore good enough to keep.
Nest Wednesday, you’ll learn about the only three reasons for selling a stock. (Hint: The first is when you want or need the money; and none is when the price goes down.)
I like the quote from your 2007 Stock Central seminar: You will buy quality stocks and hold them until: 1. You need the money, 2. The quality deteriorates, or 3. The potential return deteriorates.
It’s simple, eloquent, and comprehensive.
I tell beginners there’s only one reason to sell a stock – #2. That’s simple. We do that by plottting the most recent trailing four quarters for Sales, Pre Tax Profit, & EPS on the front of the SSG and watching for problems. It just seems too simple some times.
Another exercise we use to show the performance of defense is to to examine the effect that defense or the failure thereof has on a hypothetical portfolio of 5 stock, each expected to return 15%.
In the perfect world, each stock contributes 1/5 x 15% or 3% to the portfolio’s return. In the perfect case 5 stock each returning 3% give the portfolio a total return of the perfect 3%.
If there is one “dog” among the group of 5 and it is not removed during defensive portfolio management for thos entire 5 years, you have four stock returning 3% each and one returning 0% so 4×3 + 0 = 12% return for the entire portfolio.
You can do calculations to do the difference in theoretical portfolio returns if the “dog” is excised after 1, 2, 3, or 4 years. The sooner you do it, the better the portfolio’s return. BUT even if you waited two entire years to decide to sell the “dog”, the return is much better than never selling it at all.
You can do a quick calculation to show what the difference between selling the dog in two years vs. not selling the dog means in overall portfolio return over 30 years.
In the perfect world, each stock contributes 1/5 x 15% or 3% to the portfolio’s return. In the perfect case 5 stock each returning 3% give the portfolio a total return of the perfect 15%
15% not 3%!!!
No question but that, when you come across a company that you have reason to believe can no longer live up to your expectations for its fundamental growth, the sooner you sell, the better.
This doesn’t mean that you should sell immediately, if there’s a dip in sales or earnings growth. You will need to research to find out whether or not this change is temporary and management will be able to handle it. But, as soon as you’re satisfied that this isn’t a transient issue, sell it.
If you’re alert and fortunate enough to have discovered a significant problem before the decline in sales has reached the bottom line, so much the better. You’ll save yourself some money. Even if you catch it when the problem shows up in the growth of pre-tax profit, you’re still ahead of the game and might still be able to sell before the problem has hit the earnings. Of course, if it’s hit the earnings line, you’re joining the other sellers and your portfolio will take something of a hit. But you still should get rid of it right away.
Never wait for the stock of a company whose fundamentals have seriously slid to come back. Move on and put your money in another promising candidate.
Of course you are correct, but for beginners they MUST learn to get rid of stocks with fundamental flaws.
Most of my comments are directed at showing beginners the longer you hold the fundamentally flawed stock, the more damage it does to your portfolio’s return.
What I didn’t mention was that hopefully, the one stock in five that does much better than expected will compensate your porfolio’s return for the dog’s damage.
Good points, all.
My Vanguard account monitors my investment’s worth and diversification automatically.
What it can’t tell me is which way a stock’s price is heading; fundamental investing has this possibility.
If I calculate the assets needed for retirement, then I can see where I need to be each year to be on schedule. Those funds need to increase by a certain dollar amount each year either by investment growth or saving work-earned dollars.
Retirement is then just keeping on schedule.
I have been using a stock trading sim for nearly two years.I have put allot of time into learning the markets from all angles. In my portfolio, we start with 100k. I started a new portfolio about three months ago. A this point I have a monthly return of +15.52% & weekly of +3.57% (between Mon & Tues) and a Sharpe ratio of 4.61. Is this a “decent” portfolio in the real world and as far as a model to be used for employment within a brokerage firm? I was in the military for 11 yrs, now disabled so I have the time to watch the market all day, exacuting trades as the market fluctuates. What else should I be doing if I want to start a career in investing?
Many thanks,
Ian in Vermont
blugrsvt@hotmail.com
I also have a question regarding a home purchase that only a banker, broker or an actual originator could answer.
Ian (in Vermont),
It’s interesting that you say you’ve “put a lot of time into learning the markets from all angles” and that you’ve been using a sim to do it. Can you tell me what the market is going to do tomorrow or the next day? How high it will go before it turns around again, or how low it might go before it starts back for good?
If your answer is yes to those questions, then you can rule the world! No one else can; and I certainly can’t!
Tell me about your return during the time you used the sim. Was it as good as it has been since you recently started your portfolio?
Your question about employment in a brokerage firm is an interesting one. I wouldn’t be surprised if you could get a job with one of them because you do speak the language and they would teach you all you need to know.
But….
I have to tell you that you will probably not be a successful investor or do your clients much good if your view of the market is through the eyes of a trader! However, you can be a huge success, with a) the time you have to learn, b) your interest in the subject, and 3) a realization that good investors like Warren Buffett don’t want anything to do with the “market,” per se.
I suggest you look in the section of this blog labeled “Learning Center” and prowl around there for a while. You should come up with an understanding of why those who play the market don’t win in the long run and, more importantly, what you need to know to be a success.
I will be happy to help you learn what you need to learn if you’re open minded about giving up gambling for investing. And I’d be happy to help you be a successful investor——no strings atached and no contribution but your time. (I will always do what I can to help those who have served their country as you have.)
Write to me privately at etraub@financialiteracy.us if you want to pursue this.
OHH Some very interesting and insightful thoughts. I like this.