When to Sell - and What to Buy

09/12/2003 12:00 am EST


James Oberweis

President, Oberweis Asset Management, Inc.

The year-to-date gain in the model portfolio at The Oberweis Report is a pretty amazing 85%. However, Jim Oberweis cautions, "The beginning and end of the 'good times' are nearly impossible to predict." Here, he discusses when to sell--as well as highlighting his current top buys.

"We have traditionally focused our articles on how to find great stocks to buy. But perhaps the trickiest part of managing portfolios is determining which stocks to sell. Theoretically, the sell decision should involve virtually the same analytical issues as the buy. But the sale can be an emotional decision. When we add a stock to the model portfolio, we invest our time, our reputation, and our hearts (and, of course, our clients’ money). The predictable result, of course, is that the choice is either right or wrong. Some ideas will not work out. From e xperience, we have found that successful investors admit their mistakes quickly and move on to better ideas.

"The corollary is also true: when companies execute well, stay with them. Just because one has made a respectable profit does not imply that future additional profits need to be foregone. In actuality, there are only three relevant factors in deciding when to sell a stock—business fundamentals, the stock price, and taxes. Taxes are easiest to analyze because the effect can be precisely computed. Profits from long-term gains are taxed at a maximum rate of 15%. The typical reader will pay nearly 35% of profits to Uncle Sam if positions are sold during the first year of ownership. Therefore, if you’ve owned a position for less than one year in a taxable account, it may make sense to hold out for long-term capital gains treatment. Other than that, taxes should rarely be the determining factor.

"Business fundamentals drive most of our sell decisions. Specifically, a deceleration in a company’s growth rate or our expectation that the growth rate may slow may lead us to exit a position. Quarterly earnings reports offer critical report cards. We become quickly concerned if those comparisons show a decelerating trend. A year-over-year contraction will illuminate the exit sign. Suppose a company reported quarterly revenues and earnings that showed year-over-year increases of 30% three quarters ago, 25% last quarter, and 20% this quarter. Although the percentage increases are all excellent, the trend is moving in the wrong direction.

"The last element to consider, and perhaps the most challenging, is stock price. Stock valuation has to be analyzed in tandem with a company’s growth rate and earnings prospects, both of which are in constant flux. So the fact that a stock has moved up or down is meaningless without an understanding of changes in the company’s expected earnings growth rate. W e’ve found no sure-fire way to eliminate occasional unfavorable earnings surprises. A bad report can send a high growth stock 30% or 40% lower. As a rule of thumb, we’ve generally found that it is still best to sell quickly when bad news is out, even when the price is lower. More often than not, one bad quarter implies that there are more to come."

Meanwhile, here are four new buys for risk-oriented investors from The Oberweis Report , each of which is held by clients of Oberweis Asset Management:

"Smith Micro Software (SMSI NASDAQ) is a developer and marketer of wireless, utility, and e-commerce software. Sales for the second quarter of 2003 rose 44% to $2.3 million. Earnings per share grew to $.01 from a loss in the year-ago second quarter. Abaxis (ABAX NASDAQ) develops portable blood analyzers for use in any veterinary or human patient-care setting. Its testing system performs multiple blood tests from a single whole blood specimen without requiring a skilled lab technician. Revenues in the most recent fiscal first quarter ended June 30 increased 39% to $10.3. Earnings in the quarter grew to $.04 vs. a loss in the year-ago period. Perceptron (PRCP NASDAQ) designs information-based measurement & inspection solutions to increase productivity, improve quality, and decrease costs in manufacturing and product development. Sales for the fourth quarter grew 45% from the same year-ago period. Earnings grew substantially to $.15 vs. $.03 in the year-ago fourth quarter. Vasco Data Security International (VDSI NASDAQ) is a global provider of patented Identity Authentication security products that enable e-business and e-commerce. Its time-based system generates a one-time password that changes with every use, and is virtually impossible to hack or break. Net revenues for the second quarter ended June 30th rose over 50%; earnings grew to $.01 vs. a loss in the year-ago period."

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