The last two weeks of the year tend to stir all types of reflection, from taking stock of the past 50 weeks to looking ahead to what the new year may bring. While this reflection can be personal, business or both in nature, I would encourage all to do some reflecting on existing financial positions as well. I would include reviewing personal balance sheets; examining credit cards, respective interest rates and the companies who have issued those cards; uses of disposable income and, of course, what is held in your investment portfolio. While this may run the gamut from individual stocks, mutual funds and exchange-traded funds (ETFs), a periodic review can lead to solid decisions and subsequently better performance than if that portfolio were treated as sleepy money.
Updating data points, revisiting an original investment thesis and checking valuation metrics on a periodic basis can help ascertain if a stock has run as far as you might expect it to and avoid the "sleepy money" trap. That trap is to simply invest and forget. By that I mean, buy a basket of "good" stocks and forget about it.
If we look at the value of the S&P 500 today compared to what it was both five and 10 years ago, we will find it is has fallen 7 percent and 22 percent, respectively, as I write this. The Dow Jones Industrial Average posted losses over the same periods that equate to a 2 percent and 8 percent drop over those respective years. The same is true for even some of the better-performing ETFs this year. Consider ProShares Ultra Semiconductors, which is up 128 percent on a year-to-date basis but on a five-year basis its value is still down 55 percent. Another is PowerShares QQQ Trust, which is up 51 percent on a year-to-date basis but down 46 percent on a 10-year basis.
To be fair, there have been a number of select individual stocks that have posted far worse returns than the overall market. Two such examples include both Yahoo and Motorola. Meanwhile, others, like Apple and Cree, have posted significant returns. Although there are probably several reasons why Apple and Cree outperformed the overall stock market while Yahoo! and Motorola underperformed, one characteristic that both shared was a thesis that has continued to work over the last one-year, five-year and 10-year periods.
Apple benefited from the digitization of content and built on that success with incremental products, such as the iPod, iTunes, iPhone and more. Cree was a pure play on light-emitting diodes and solid-state lighting, which flourished not only under green investing but also a new generation of lighting technology for various consumer products, including mobile phones, notebook computers and now TVs.
So how do we begin clearing the portfolio of those stock positions that should be pruned? Well, it's a tad difficult without knowing each position, but there are some general rules of the road.
The first step, in my opinion, is to check the original investment thesis. Several columns back I mentioned the investment notebook that I use to keep thoughts, data points and other observations for the stocks I buy, sell and keep tabs on, on a personal basis. It's in this notebook that I can retrace that original investment thesis. Has a product launch been less than expected, like that of Palm's Pre smartphone? Has the competitive landscape changed or has the industry shifted? One example would be the shift in the mobile phone market from basic mobile devices to smartphones. Sticking with Palm, its position in the early days of the smartphone market is rather different from what it is today as the competitive environment has intensified. Both existing players, like Nokia, Motorola and Samsung, and new ones, such as Google, have zeroed in on the smartphone space with more in the wings. The market has shifted toward smartphones and favored touch-enabled devices that open up new markets for a company like Synaptics. That is a great example as to how a company expanded into new markets as new applications for its touch-enabled products became available. Another is how Apple has ridden the digital consumer wave and driven functionality as component price points have collapsed.
Is the company's earnings stream accelerating, decelerating or contracting? If that stream is slowing or shrinking, is it a company-specific event or an industry one that is the culprit? If it is an industry one, again, how is this reflected in your thesis and how is your company performing against its peers? If earnings are accelerating, what is the primary driver above the operating profit line, or is it some financial engineering below that line?
Are the shares of your investment expensive? Before we jump to a quick conclusion by looking at the share price, we need to first ask: how do the current valuation metrics stack up against the peer group, compared to historical multiples and relative to expected earnings growth? Based on these last two questions, you'll have a better sense as to how expensive the shares really are. Once we know how current metrics compare, we can ask if that offers opportunity because the investment thesis is intact and the shares are mispriced or if it's another sign that the investment thesis is broken.
If your original thesis is no longer intact, if the shares are expensive on several valuation perspectives or if the shares are bumping up against your price target, then you should strongly reconsider holding that stock. Moreover, if this happens to be the case and you are underwater in the position, it may be time to look at the investment in a more cold-blooded manner, rather than holding on too tight to the idea and wanting to believe it may work if you only hold on for just a bit longer. Better to cut your losses and identify an opportunity with better prospects.
Again, this is a down and dirty checklist. That said, in my opinion, do yourself and your portfolio a favor, listen to the data rather than the emotion and free up some capital to put to work in ideas that are better positioned to outperform the market in the coming months and quarters, if not longer.
• Chris Versace is director of research at Think 20/20 LLC, an independent research and corporate access firm based in Reston. He can be reached at cversace@ washingtontimes.com. At the time of publication, Mr. Versace had no positions in companies mentioned. However, positions can change.
Chris Versace, the “Thematic Investor,” is the director of research at Think 20/20, an independent equity research and corporate access firm located in the Washington, D.C. area. Before Think 20/20, Mr. Versace was the portfolio manager of Agile Capital Management (ACM), a thematically driven alternative investment fund. The groundwork for ACM was laid during Mr. Versace’s tenure as senior vice president of equity ...
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