Don't Sell Low
- 2001 4 Apr
A light rapping can be heard throughout the house. Someone is knocking at your door. Being a sociable person you answer it. Opening the door, you are surprised and somewhat alarmed to see a stranger standing on the doorstep. He is smiling and looks harmless enough, so you ask, "Can I help you?"
His smile widens and he says, "Yes, I think you can. I have been doing some research, and I like your house. The neighborhood is nice and your neighbors seem to be good people."
With a wrinkled brow, you answer. "OK, well, thanks ... I think ... but what do you want?" "I want to buy your house," answers the stranger. "My name is Bob," he says and he extends his hand. You shake it and say, "What did you have in mind?" The business side of you is quickly computing your last appraisal. The house was worth $200,000 a year ago, and nothing inside the house or in the neighborhood has really changed.
Bob says, "I want to offer you $50,000 for this house. I think it is a reasonable offer and something you should consider." Alarm bells begin ringing, and you stare incredulously into his eyes. Even if the housing market had softened, there was no way the house was really worth only $50,000. "Thanks, but I am not selling," and with that you bid Bob farewell. Closing the door and shaking your head, you move to the window. Bob is moving to the doorstep of your neighbor's house. Obviously, Bob is still in search of someone who might sell out below appraised values.
In this scenario, it is easy to assume that you would pass on Bob's "offer" and would hold on to your house until someone offered you the appraised value, or better yet, even more.
The same should hold true in the stock market. Just because the stock prices in the markets today are low, does that mean the underlying business has dropped off dramatically? Usually the answer is "No." Was Cisco (CSCO) overvalued at $75 per share? Probably. Is it undervalued at $14? Most likely. The market is driven by emotion and often over-reacts to news and economic events.
In only 12 months, we have gone from "this time it is different" to "tech is dead." How is that rational? The simple answer, it is not.
Follow some simple guidelines to help avoid the mistakes of selling low and buying high.
1. Understand that the most important event in owning stock is the initial purchase. Know why you believe this price is a good entry point and a good value.
2. Have a rigid sell discipline. Deterioration of the company's fundamentals, management change, merger or acquisition or decline in cash flows are examples of good reasons to sell. Macro events and stock market emotion is not a good reason.
3. Own good companies making money. In bull markets nearly all stocks work well, but in bear markets, earnings and cash flow are extremely important.
4. Don't overextend. The main reason for selling at bottoms is that investors overextended themselves during good times and got too aggressive. Diversify and be ready to hold.
If you are not comfortable making these determinations or do not have the time, consult a professional. A good professional can help you avoid the pitfalls of selling low and buying high.
Written by Craig D. Van Hulzen. He is president of Van Hulzen Asset Management. Comments and questions can be sent to firstname.lastname@example.org.