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Sep 3, 2019

Selling A Loser Of A Stock

by Benj Gallander

Benj Gallander and Phil MacKellarAnyone who has invested in the stock market for something more than a nanosecond will have some losers. One major problem is determining when to sell these duds. Ultimately holding them can mean that the loss becomes even greater, as more money disappears into the toilet so to speak. Thus, here are some thoughts on how to avoid stock routs. It is certainly an incomplete list, but if a number of these factors are in play, it could be time to dump. We have included some other thoughts on dealing with failures.

1)             On a regular basis, you should be re-examining purchases. This becomes particularly important if the stock is beaten down. Does the initial thesis for buying the position still stand, or have there been major changes that designate that this is not the stock acquired?

2)             Revenues are being slashed. This is particularly important if there is a heavy debt load, debt is contracting slower than revenues or the debt is growing.

3)             Annual operating cash flows are negative. Losing money is bad, especially over the long run as it erodes the health of the balance sheet and the company’s ability to bounce back.

4)             The current ratio is dropping and becomes less than one. This is a liquidity ratio that shows how well the company can cover payments due in the next year.

5)             Financial covenants are breached, which puts organizations at the mercy of lenders.

6)             Short interest is dramatically increasing, and/or a large share of the float outstanding is short. Though these people are not always right, they get it correct often enough.

7)             If the company proposes a share consolidation, that is almost always a wise time to jump ship, as normally soon after the action is completed, the stock price withers. Often the reverse stock split is proposed when a stock is trading below $1.00 and the enterprise wants to keep its listing on the stock exchange.

Psychologically it can be difficult to off a losing position. Sometimes investors convince themselves that by not selling, they have not lost money. That is like believing the scale is broken when it registers high numbers. While hope can spring eternal, keeping a dose of reality in the forefront is much stronger than wishful thinking. Selling losers effectively means admitting fallibility. For some people that is very difficult to do. But better to do that than be stubborn and watch good dollars disappear after bad.

Some people wait until towards year-end to sell their losers. This is almost assuredly a way to have more funds chipped away. As often many other stakeholders are selling too, this increases the supply of stock, lowering the price achieved. Personally, we prefer to sell in spring, when there will not be this impact. Whenever sold, a thoughtful plan to offset taxes on capital gains is important. That means less money to the Canada Revenue Agency (CRA), leaving more in the kitty to invest.

Some pundits believe that an excellent way to avoid blowouts is to place stock losses. Personally, this does not work for us. For example, if a trailing stop loss is placed at 10 percent, under normal circumstances the shareholder will sell the position before the full gain can be achieved. That can be caused by a stock market rout that can take most companies down in value or simply because of a bad day or two for the individual enterprise. In other words, this can mean throwing out the baby with the bathwater. It is better to use mental stop losses, which means that the company must be regularly examined, especially if the price is falling.

Sometimes a danger exists of selling a loser before it turns and has a steep climb. Balancing risk-reward is not simple and of course it is much easier to recognize mistakes retrospectively. Alas, clear crystal balls and tea leaves that read the future seem to be lacking in this regard. We sometimes chuckle when we see advertisements that say something like, “If you bought ABC Corp. at $1.00, you would have a ten-bagger now”. Uhm, sure, if only. They don’t write about it when it reverses to a dime.

Unfortunately, there are no perfect ways to avoid duds in the stock game, unless you choose not to invest. But by selling the ugly ones sooner rather than later, more money can remain in the kitty to fight another day. While psychologically admitting failure can be difficult, at the end of the day, selling comprised positions is critical to staying in the game and enhancing retirement.

 

Benj Gallander, MBA, Co-editor of “Contra the Heard”, Toronto, ON, gall@pathcom.com, www.contratheheard.com

Phil McKellar joined the Contra team on a part-time basis in 2011 and has been investing since the early 2000s. He has been with Contra full time since 2014, before which he was a financial advisor for Freedom 55 Financial and an analyst at New Energy Finance in the United Kingdom.

More recently, he was an analyst at Sustainalytics, where he assessed the environmental, social and governance dimensions for forestry, mining, steel, and utility companies.