The Art Of Selling Non-Performing Stocks

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Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Apr 04 2019

In this week's Weekly Insights:

-The Art Of Selling Non-Performing Stocks
-Conviction Calls
-Have Your Say - The CSL Challenge

-Rudi On TV
-Rudi On Tour

The Art Of Selling Non-Performing Stocks

By Rudi Filapek-Vandyck, Editor FNArena

It is undoubtedly the most difficult decision to make for investors in the share market: when is it time to sell?

I am not talking about when to jump off perennial high-flyers such as a2 Milk ((A2M)) or Altium ((ALU)), where the decision most likely translates into when do I start crystallising some of my profits, and by how much? - I am talking about that part of the investment portfolio that is least talked about: the dogs, the bad decisions, the 'it looked a good idea at the time' losing positions that continuously test our character, our resolve and confidence, and possibly our mental sanity.

Just to be clear: owning a few bad apples in portfolio is not something that happens to inexperienced, unlucky or lesser informed investors only. It happens to all investors of all colours, shapes, and levels of experience.

If we take guidance from the fact that, as a general rule, good stock pickers average six out of ten winners, with five (50%) more likely and seven being exceptional (also: exceptionally lucky), simple logic tells us not every investment decision lives up to its potential or expectations. At least not right away.

Impatience seems seldom the correct response, but then a lot of investment capital goes out the window each year from investors holding out for a share price recovery that simply won't arrive.

?

After losing in excess of -60% between February 2015 and mid last year, Telstra shares have recovered somewhat and stabilised between $3-$3.30, but this still leaves faithful hangers-on with a big hole in their pocket, requiring many years of dividends to possibly make up for the gap.

Things are looking a lot worse for loyal shareholders in AMP, or iSentia, or Retail Food Group.

"Don't fight the tape" and "don't ignore the trend" are typical statements heard from shorter-term traders, but not every share price that falls is doomed. Take one of my favourite stocks in the share market as an example; TechnologyOne ((TNE)).

Between September 2016 and September last year the stock simply could not attract any positive momentum. Today the share price is up by 50%, and it all happened in a heartbeat, really, without major new developments or a major announcement from the company.

One of my other portfolio constituents, Bapcor ((BAP)), could literally do no wrong throughout the whole of 2015 and up until the third quarter of 2016. During this period Bapcor shares turned into a popular go to destination for many an investor in small caps. Then followed a period of absolutely no appetite among investors, until the share price exploded to the upside between April and September last year. Currently we're back to "no appetite" again.

My most famous observation relates to late 2016 when CSL ((CSL)) shares, having temporarily peaked at $120, continued to fall ever deeper and all the talk on TV was how far down the share price would ultimately end up. As it happened, CSL shares sniffed at $90, then quickly turned around and hardly ever looked back. They are close to $200 today.

As an investor, you'd feel mightily guilty if you had allowed short term "noise" (because that's what it is) to infect your mindset, leading to the misguided decision to sell all your shares in CSL. I'd wager, the same applies to the expert who last year declared he'd sold out of TechnologyOne because the share price "wasn't doing anything".

The offset is, you'd feel far worse if you are still holding shares in AMP, iSentia or Retail Food Group. So how do we distinguish the latter from the former? When do we sell and when do we hold on and possibly buy even more shares?

Judging from my own experiences, there is no single golden rule, but a lot of confidence stems from thoroughly understanding what the company is about; what it does, how it operates, how it compares to its peers, whether industry dynamics are changing and who's benefiting, et cetera.

Admittedly, it's not always clear, nor easily established what exactly is weighing upon a given share price, in particular not when other parts of the market are trending upwards.

But if your company in question is of high quality, with a robust growth outlook under the belt, and there is no particular bad news or negative development impacting on it, you are able to feel a lot more relaxed about the falling share price. In the case of TechnologyOne, this company -virtually without exception- grows at around 15% per annum, and has been doing exactly that for well beyond a decade now.

When management announced growth would be less for the financial year ending in June 2017 -only at 7%- this was interpreted as very negative news by the market. As it came on top of a project dispute with Brisbane Council plus a dismissal court case by a former executive, it was all too much for most. By now the company is growing back at double digit speed, and guess where the share price is?

All-time high.

Sometimes, however, the company in question does not own that same high quality label, and its growth profile has been impaired. Maybe the facts have changed since we jumped on board, or maybe we just erred in our judgment. All too often our interest is triggered by a seemingly attractive looking share price, and all too often do we find out, the hard way, there was a very good reason why the share price looked "cheap".

Most investors try not to over-pay when making purchases in the share market, but according to my long-standing market observations many more unfavourable investment decisions are made, every single day, by investors trying to jump on "cheap" bargains. The problem often then becomes that the share price simply becomes even cheaper. Now, what should we do?

Let me first point out that making mistakes is simply par for the course. It will happen, and it will happen again. Take this prime piece of advice from someone who in the past has allocated positions in Slater & Gordon ((SGH)), Vocus Group ((VOC)), Pact Group ((PGH)), and EclipX Group ((ECX)): it never is too late to sell.

So rule number one should be that every decision and judgment needs to be made independently from what we've paid for our shares. All too often investors won't sell at a loss, which can be the ideal starting point for accumulating much larger losses. Have a look at price charts for the companies I just mentioned. Can you see why I am happy today the portfolio no longer hold these shares?

It always can get worse, still. Companies on occasion are forced to call in administrators, instantly making their shares worthless as happened last year with RCR Tomlinson.

Time to also call out averaging down as a high risk and very dangerous practice, all too often employed by investors trying to cover up an error. What you are in fact trying to do is make a dud investment better by throwing more money at it. Probably the best warning is through going back to the price charts of iSentia, AMP, Retail Food Group, and the like, and see for yourself how this practice can lead to ruin - only because you cannot admit to yourself that you have made an error.

Why risk making it far, far worse? Get over yourself!

I have never averaged down on a dud investment, and I will never do it. On occasion, I increase positions after a pullback, but that's because I remain convinced I am buying more of a good opportunity. I am not throwing good money after bad at the risk of incurring even larger losses (while your average price might fall, your total exposure increases).

One of the clearest warning signs I have found stems from companies issuing disappointing statements. Looking back at the early days of my allocation in iSentia, small disappointments seemed always included, and they simply grew bigger until it could no longer be denied here was a company in deep troubles (by then I had already jumped ship, thank goodness).

It's a harsh lesson also experienced recently by shareholders in Pact Group and EclipX Group, with both management teams issuing yet more bad news announcements, further depressing the share price. "Value" in a share price is directly linked to how the business is operating. If there is no trust left in what the company actually can and is likely to achieve, do you still want to be around hoping for the best?

Probably the second most common error is investors being hoodwinked by a seemingly high dividend yield, too often ignoring the fact that an above average yield can be a warning signal indicating the dividend might not be sustainable.

AMP used to be a dividend staple, until it wasn't. Telstra used to be everyone's go to non-bank dividend favourite, until the share price eroded by -60%-plus. Investors should understand that Bank of Queensland ((BOQ)) shares are offering 8% plus franking at the present share price because the market sees a prolonged period of declining profits and cashflows.

It doesn't mean Bank of Queensland will 100% guaranteed announce a dividend reduction at its upcoming interim report release; but the risk of such a cut being announced while industry dynamics keep the squeeze on is certainly rising. Do you want to be exposed to such risk? In similar vein, National Australia Bank ((NAB)) is offering the highest yield among the Big Four (7.4% plus franking), for exact the same reason.

I have often pointed out in the past, and happily repeat the warning here again: the share market signals risk through yield. A low yield means the company has strong growth prospects, and is likely to deliver. A high yield, in particular during times of low interest rates and low yields on government bonds globally, means the company has very little prospects for growth, and investors better watch its cash flows.

If anyone's looking for examples for both extremes, consider Goodman Group ((GMG)) and Charter Hall ((CHC)) as part of the low yielding, robust looking, quality growth performers, whereas SG Fleet, Michael Hill and Apollo Tourism & Leisure are offering yields well, well above the market average.

Another observation is that all major banks in Australia are now either offering 6% plus franking (CBA and ANZ) or 7%+ plus franking (Westpac and NAB) which in itself is the market expressing its concern regarding the local housing downturn and ongoing impact on Australian households' savings, budgets and spending.

The best protection against a perennially bad investment remains, of course, to only buy high quality companies with a proven, robust track record, but during times of disruption and rapidly changing global trends any list of such companies on the ASX will always have a limited number of names on it.

And then there is the wide dispersion in views and opinions about what exactly makes a company high quality. Few will deny CSL is one such high quality achiever, but is BHP Group ((BHP))? JB Hi-Fi ((JBH))? What about Macquarie Group ((MQG))?

One thing can be put forward without the slightest hint of ambiguity: quality companies do not issue a profit warning by -42% seven weeks after repeating guidance for the year. This takes me back to earlier observations: share prices can come under pressure for all kinds of reasons; management teams can disappoint in many ways. CSL, for example, disappointed in February because it didn't upgrade guidance for the full year. TechnologyOne in 2017 disappointed because growth would be lower than in prior years.

Sometimes all market participants want to hear is "they missed", or "they disappointed", or "earnings estimates are being cut" and thus share prices can remain out of favour for much longer than we'd like or expect. But there is a big difference between the market getting all hyped up over a lot of short term noise and a company missing its own forecast by -42%. I'd hope we can all agree the latter is not characteristic of a high quality company.

Sometimes, during times of ultimate despair and confusion, we can also take guidance from the share price. I am loathe to put too much "value" on share price movements in the short term, as they can deceive as much as they can guide, but there is one trend that should be on every investor's radar; when a share price continues to trend lower, following up with lower highs and lower lows, it is time to put your ego aside and take your losses, before they become too large.

In line with the yield-risk indicator I mentioned earlier, this too is the share market sending you an unambiguously clear signal that all is not well with this company.


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