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Clear Thoughts
How and why do we choose to sell a stock?
Originally Published Friday, December 3, 2004
| Fundamental data and stock price movements are two drivers that cause a sale or a buy. When these change, how do the stocks in our portfolios change? |
How and why do we choose to sell a stock? The following may be a snoozer to read, but is key to our performance.
Almost all money managers like to explain and discuss their process for purchasing stocks. Few like to discuss their sell discipline. It is easy to be enamored with a company, its story, growth rates etc. It is much harder to say good bye.
Our sell discipline is simple and is tied to the same principles as our buys. It is based on our screening and ranking process. There are two basic and related drivers that can cause a sale: fundamental data and stock price movements. Our computers are constantly evaluating the entire set of fundamental and price information available at any point. When these change, our computers' opinion also does. If our computers' opinion changes sufficiently, they may recommend a sale. This also occurs when some other company's stock has become more attractive on a relative basis.
The goal for each portfolio is to own the best rated stocks of that market cap and style (growth or value). Therefore, as stocks fall in our rankings, we sell shares and eventually could sell completely because we own the highest ranked set of companies possible for each portfolio.
When a stock we own goes up in price its valuation rises. This may cause the stock to drop in our rankings, because our computers believe it is no longer as good a value, or growth at a reasonable price, as it once was. However, if accompanied by a rise in other fundamentals such as revenue and profits, the stock may remain highly rated. Depending on the magnitude of the movement in price, the stock may no longer be considered a value stock and could move onto our growth portfolio screens, or its higher market cap could potentially cause it to move to a different portfolio.
When a stock goes down in price its price to earnings (PE) ratio decreases. This could bring a higher ranking and trigger an additional purchase, if the fundamentals remain stable. But if the fundamentals are deteriorating, a stock's rank could decline and force a complete sale.
If a stock has improving fundamentals, without an increase in stock price, it can move rapidly up in our rankings, forcing other stocks to move down. This may have us sell one lower-rated stock to purchase the higher ranked stock. Conversely, if a stock has deteriorating fundamentals with no material change in stock price; it will drop in our rankings and potentially be sold. Additionally, we may rebalance the whole portfolio's weightings to make room for how much of each stock the computer program dictates we should own.
At Clear Asset Management, we believe firmly that discipline in selling is just as important as in buying. And our investment practices enforce this discipline, such that we continually hold only the best prospects as rated by our computers at all times while avoiding style drift. We owe this to you, our investors.
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