First, a point of clarification: Neil Sedaka is a singer-songwriter, not a stock analyst. But the title of one of his ditties contained enough wisdom to easily inspire a thesis in behavioral finance. That is:…
First, a point of clarification: Neil Sedaka is a singer-songwriter, not a stock analyst. But the title of one of his ditties contained enough wisdom to easily inspire a thesis in behavioral finance. That is: Breaking Up Is Hard to Do. Or if you like: Divesting one’s portfolio of sow’s-ear stock disguised as a silk purse is hard to do.
Just ask loyal, longtime shareholders of General Electric Co. (ticker: GE), who still hang on hope against hope for a comeback. Surely GE’s recent spate of ill fortune can’t be a harbinger of crash and burn? Or could it? Regardless, keeping the faith is quite the tall order when GE cut its once-mighty dividend to a penny last month. Again: One cent.
That might seem like a typical example of Hard Luck on Wall Street. But the fact is that less than a year ago, GE was a dividend king that had only cut its shareholder payout once since the Great Depression. Then came a shocking slash from 24 to 12 cents per share quarterly in December. Meanwhile, the share price hovers near $8 per share: down more than 70 percent since this time in 2016.
And so the question every jittery sweetheart knows: Hang in there for better or worse … or cut your losses before richer becomes poorer?
If you’ve been wrestling with that very question as you watch your cherished stock certificates turn into birdcage liner, take heart. It’s a hard one for the experts to answer, too.
“This is the most important decision in investing,” says Michael Sedlak, managing member at Golden Trail Advisers in the Chicago area. “In 1996, I went to an investor presentation in San Diego called, ‘Good Morning, Is It Time to Sell Yet?’ The most important decision is also the most difficult.”
Sedlak sees it this way: Other than cash flow needs, “The only reason you would sell would be when the future expectations are below your target.”
This much we also know: Crystal balls and Ouija boards do not work. But then again, sometimes much more precise methods don’t do the trick, either.
“Technical and fundamental analysis is usually useless as a trading edge,” says Dejan Ilijevski, president at Sabela Capital Markets in Munster, Indiana. “Mindless strategies like mean reversion work until they don’t and you suffer a blowout. Fundamentals are priced in. And no one can predict tomorrow’s news.”
So then what? That’s where the aforementioned behavioral finance comes in. For often, an investor’s best bet is to leverage insight into their own quirks. Consider this: “The emotional gain from locking in the profit is lower than would be the emotional distress from realizing the loss, so we keep the losses longer,” Ilijevski says.
Also, context is key. So the call to hold ’em or fold ’em takes on a whole new slant when the stock in question is viewed in light of a larger portfolio.
“In my firm the financial plan is what determines when to sell a stock,” says Wes Shannon of SJK Financial Planning in Hurst, Texas, “There are clients for whom we’ve identified clear goals and when we reach those goals, we sell or buy. I try to keep clients focused upon their needs and desires and to be reactive to the markets.”
Now, let’s return to the GE example. Lights out? Not so fast. “Right now I have a client with a position in GE and currently the portfolio is meeting his retirement income goals without the GE stock — so we can afford to continue to hold it,” Shannon says.
Enter the wisdom of billionaire investor Warren Buffett. The Oracle of Omaha is famous for saying that he likes to buy into some companies when “they’re on the operating table.” GE might be just such a patient worth seeing.
Rewind to the financial crisis, when Citigroup ( C) was on life support. A stock that clocked in just shy of $525 per share in June 2007 sank to $18 by March 2009. That’s a plummet of, oh, more than 96 percent. But while others sold in horror, others swooped in — and have since seen a 260 percent return. Granted, you’d still be off by 88 percent from that giddy 2007 high. But holding on and doubling down would’ve certainly eased the blow, or even erased it.
Then again, some reasons for quitting a stock prematurely have nothing to do with the stock itself.
“You might sell because you think that you need to diversify your portfolio, or need to pay for your kids’ education, or need to make a down payment on your house,” says Peter Kelly, assistant professor of finance in the University of Notre Dame’s Mendoza College of Business. “So there are a lot of reasons that would be unrelated to the company’s underlying financial information.”
Kelly has pinpointed one metric that might offer a clue on whether to cut the cord. In his study “The Information Content of Realized Losses,” Kelly used historical stock market data to answer the question, “Do insider stock sales predict future returns?” Turns out, they do: When insiders sell company stock for a loss, the stock’s subsequent six-month return is 188 basis points lower compared to other such periods.
At least paying attention to those stats will serve a nervous investor better than blood pressure numbers or the decibel level of breathless investment pundits.
“Two data points do not make a trend, whether that’s a stock price, a quarterly profit number, or any business metric,” says Mark Graban, a consultant, management expert and author of “Measures of Success: React Less, Lead Better, Improve More.”
“There’s a real tendency to over explain any small up or down in numbers we face in life,” Graban says. “That includes a stock’s price or the number we see on the bathroom scale each morning.”
Sound advice for anyone whose portfolio anxieties weigh on them.