Immediately after purchasing a stock, it is imperative to establish, monitor and sometimes adjust upward (but rarely downward) the price at which you are willing to sell.
The following scenarios may be cause for concern.
The revenue and per share earnings of the company fail to live up to Wall Street estimates for a given quarter. Ours is an industry of expectations and should a company fail to live up to these expectations, chances are that for some time the stock will have a difficult time making headway until it re-establishes its credibility. We apply the cockroach theory inasmuch that where you find one cockroach, there are usually many more. Furthermore, quite often, one bad quarter begets another. Despite the above, what would cause us to hold on to a stock is if the stock price responds positively despite the bad quarter. This is typically a sign that the stock has bottomed out.
There is a shake-up in upper management. Reorganizations quite often precede bad news and such a shake-up could be a telltale sign that some bad news is coming. The accompanying press release usually states that “so-and-so is retiring to ‘spend more time with his/her family.’” Once again, watch how the price of the stock reacts to the news of a change in management. Be observant, quite often, this could be a time to buy.
The reddest of flags pertains to undefined or defined accounting issues. Should a company (see Enron, Worldcom or Tyco) announce that they are conducting an internal investigation or, more worrisome, that the Securities and Exchange Commission is conducting either an informal or formal investigation into the accounting practices of the company, run for the door. Remember, when you sell a stock, you are not saying “no to the investment forever,” but rather “this doesn’t make sense right now.”
The final reason noted in this column pertains to the company changing its strategic direction. Quite often, when a company embarks in a new direction it is because the old direction was not working and that this new direction should be the panacea. However, this “new direction” is often laden with pot holes as the company finds its way. Better for an investor to step aside and take a wait and see approach rather than to continue on the same course.
Finally, as noted above, don’t just blindly sell a security should one of these events occur. Rather, wait and see how the stock reacts to the announcement. As mentioned, quite often, the reaction of other investors to these issues should ultimately determine your course of action. Should the stock rise, watch closely, but wait to sell. Should the stock fall, perhaps you should also exit. Either way, be disciplined in your approach to investing. Emotional decisions usually prove wrong.