Investment portfolios can do with a spring clean to avoid stocks reaching their ‘best before’ date. Fiona Clark provides six reasons to clean out your client’s investment pantry.
This spring I had a particularly good time in my pantry.
I’m only half jesting, because even though the actual act of cleaning is laborious, time consuming and a little gross, there is nothing quite like the feeling of restored order; neat rows of labelled Tupperware containers next to stacked tins, labels facing out, grouped according to content type and cuisine ethnicity. I may be a little weird that way…
The pantry shenanigans got me thinking about how easy it is to decide when to toss something food-related.
Food provides obvious clues such as ‘use by’ or ‘best before’ dates; even without these there are the strange smells, the even stranger growths, the solidification or crystallisation and, my personal favourite, the inability to determine exactly what is in the container.
If only the cull was so easy for other things. Like an equities portfolio. Surely, there are easy rules of thumb to give an indication of when a stock investment had reached the equivalent of its ‘best before’ date?
After some intensive research, consisting of grilling my investment colleagues in the tea room, six top reasons emerged for why a stock needs to be thrown out of your investment pantry:
1. It has been a big disappointment
Okay, so the stock you thought you loved has fallen 40 per cent, but surely it’s time for a rally.
But maybe it’s not. You could be missing out on better opportunities elsewhere.
Don’t be afraid to cut your losses.
2. There’s a profit downgrade
After the shock has subsided, you feel a little disappointed, but at least it’s out in the open and we can all move forward with the restructure, cost-cutting, strategic overhaul or whatever the company announces they are doing to solve the problem.
Unfortunately, sometimes a profit downgrade is a symptom of a bigger problem, and a single profit downgrade doesn’t stay “single”.
This doesn’t mean you should sell every company that lowers its forecasts – sometimes an initial sell-off is actually a good time to buy a turnaround company.
However, it should raise an alert in your mind: do you think this is a once-off or would you rather put your money, and your risk, somewhere else?
3. It’s ‘fashionable’
This is also known as the “taxi-driver rule” – if everyone is calling the stock a “buy”, including your cabbie, then there is nobody left to buy it and hence the outlook is limited due to a lack of future interest. Or, to put it another way: from the top, the only way is down.
4. The “trend” is your friend, but with friends like these …
This rule is similar to the rule above but broader.
For example: it’s a low-interest environment so let’s all look for companies with high yield; or, no-one goes into shops anymore so let’s buy defensives and internet retailers.
Whatever the trend might be, it’s important to be aware of what’s driving the share price.
The companies themselves might be okay but the share prices might be a little too high. Don’t be afraid to go against the trend if you think it’s looking overdone.
5. Changing tastes
So maybe the trend is a bit overdone and reversion will eventuate (as an example, we might decide that a little customer service is worth a little extra money)…or perhaps not.
Knowing when a trend signals a significant change in the way business is done or the way we live our lives is very difficult, but if it’s permanent, it’s time to get “with it” or get out (remember Kodak?).
6. It reaches your target
Almost everyone gave this as their first response. But what does this really mean?
Stock brokers are notorious for increasing the target prices of companies as the actual share prices rise and it’s understandable.
Should we be more disciplined, using the equivalent of an automatic stop-loss but on the upside, sort of a stop-gain? I don’t think so.
A real loss “hurts” more than the opportunity cost of not participating in the full price rise.
So if your initial target is reached, it seems like a pretty good idea to take the rose-tinted glasses off and seriously consider if the future can continue to be so rosy.
In the end, your investment “pantry” should look a little like the real thing. A few staples, like some flour, salt and pepper, tinned tomatoes and rice.
Not exciting but necessary.
Add a few more interesting and exotic things; maybe some curry paste, quinoa or tamarind. Just to add some spice. So long as it’s all within the best-before date.
And it doesn’t smell a bit iffy. And…you get the picture.
Fiona Clark is a senior investment analyst with Prime Value Asset Management.
