How to deal with stocks that let you down
How an investor handles disappointing stocks can go a long way in determining success, says this U.S. advisory, which has four examples.
A stock has let you down. It’s almost like a personal insult.
Your first impulse may be to just get rid of the thing. But then you calm down and think again.
You bought the stock for good reasons and if those good reasons haven’t evaporated, maybe you shouldn’t give up too easily.
On the other hand, if something has decidedly changed for the worse, it may be time to cut your losses.
Here’s how a leading U.S. advisory puts it. “In the real world, stock market disappointments are inevitable — and the handling of such setbacks goes a long way in separating good and bad portfolio managers.”
The advisory is one that has precise criteria for rating stocks. Dow Theory Forecasts has a long-established system it calls Quadrix, which measures stocks for momentum, quality, value, financial strength, earnings estimates, performance, and volume metrics.
Theoretically, if a stock can pass this exhaustive test, it should hold up in the market.
So what to do if it doesn’t? We’ll see how Dow Theory is dealing with disappointment in four separate cases.
Recipe for subpar returns
When the warning signs go off, it is important to make a distinction between disaster and temporary disappointment, says this advisory.
“We will typically sell a stock on truly worse-than-expected earnings news or a big drop in Quadrix scores, as our strategy centers on limiting our portfolios to our best ideas. But dumping fundamentally strong stocks on minor setbacks is a recipe for subpar returns.”
Here is how it is dealing with stocks “that have not worked out exactly as planned.”
Legal trouble
The first alarm goes off in the complex world of patent drugs. AstraZeneca (NYSE-AZN) is a major pharmaceutical firm with headquarters in Sweden and London.
It has gained wider use in the U.S. for its schizoprenia drug Seroquel XR. And its cholesterol pill Crestor will join it if regulators follow the advice of an advisory panel. And it has filed for approval of a blood clot treatment that has already done well outside of the U.S.
This looks like good news, yet the shares went into decline. The chief problem is legal trouble.
AstraZeneca has agreed to pay $520 million to settle a lawsuit over the marketing of Seroquel in the U.S. And it may face many more suits from former patients claiming the drug caused diabetes and other woes.
The company pays its $1.18 dividend in U.S. dollars. It yields 2.5 per cent and its trailing price/earnings ratio is a modest 9 per cent. So the advisory is willing to keep AstraZeneca as a buy, “but we are anxious to hear any Seroquel or product-development news when December-quarter results are posted on January 28.” In fact, the price has risen sharply in the short time since this issue went to press, from $46 to $50.
The price of oil
Oil giant Chevron (NYSE-CVX) has been a favourite of this advisory for some time. But its Quadrix score has dropped to the lowest level of any single stock the advisory recommends.
The company’s operations are more heavily tied to the price of oil than its peers. That is a potential short-term advantage, and the stock has risen since last spring, albeit in stops and starts. For the long term, success also depends on a big liquefied natural gas project in Australia.
Chevron’s results were not inspiring in the last quarter, as per-share earnings and revenues fell. But the March quarter is expected to be much better and earnings are expected to jump over 50 per cent for 2010 as a whole. Therefore, Chevron is kept on board as a long-term buy.
Trading at $78.60, it yields 3.4 per cent on its $2.72 dividend.
Subscriber fees
Comcast (NASDQ-CMCSA) saw its shares jump when it bought a majority stake in NBC Universal from GE. The deal looked airtight.
Comcast gave up $6.5 billion in cash and $7.25 billion in assets for its 51 per cent stake. But with the venture valued at $28 billion, there were no fears of depleted cash reserves and an onerous debt load.
But now the shares have gotten bogged down. The big worry is programming costs. There are many machinations going on in the cable TV industry. News Corp recently announced a deal that will oblige Time Warner Cable to charge a subscriber fee for Fox network.
Comcast’s contract with CBS is up for renewal in 2011. So what new fees might it face? Not enough to push it off the buy list. Armed with its new acquisition “it seems capable of a rally above $21 over the next year,” says the advisory. It trades today at $16.78 and yields 2.3 per cent on a dividend of $0.38.
Poor results
Lastly, there is National Oilwell Varco (NYSE-NOV) builder and outfitter of drilling rigs. This firm has admitted that tight credit markets could delay a full recovery in the energy industry.
There has been good news in small doses — the rise in the price of oil, and a recovery in the number of rigs devoted to natural gas.
But this company’s poor results for the last quarter are still weighing on its Quadrix scores, says the advisory. Profits and revenue fell sharply from the year before. Worse still, the order backlog was down 16 per cent.
Of the four, this stock is closest to the precipice. The advisory is keeping it as a buy, “though we may downgrade the stock if December-quarter order trends disappoint or the stock moves into the mid-$50s.”
The December report is due on February 3. Meanwhile, a move into the mid-$50s would push the shares to the limit of their value. They trade today at $46.42 and yield a meager 0.8 per cent on a 40¢ dividend.
In none of these cases has the stock been dumped. Carefully looking at specific problems, the advisory finds that for each of these companies, the long-term gains are liable to outweigh short-term pain.
It’s not always easy to make that decision when the share price is falling. But it may help to remember that once you’ve sold out, you’ve locked in your losses forever.
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