During the 3rd quarter of 2003, many physician-investors had the same question in mind: What should we do with a stock that has gone up in value? To find an answer, you'll need to use a probing, analytical process. The probe ends with the technical analysis/ trend observations step, which, on its own, can lead investors into many poor decisions. There are several initial steps investors should first employ.
From the Beginning
A stock candidate for purchase would first have to satisfy the global observation step. This step requires that a stock be considered a beneficiary of an identified global economic theme or trend. The analysis of a company's financials is step 2 in the stock selection process. In examining fundamentals, investors evaluate a company's financial statements (eg, income and cash flow statements and balance sheets) to determine relative ratios.
Many investors sell stocks prematurely because the stocks have met a predetermined price target, only then to see another major advancement. To avoid this unpleasant experience, you should continually analyze a stock's fundamentals as well as its technical trends before selling, even though the stock may have reached your predetermined price target.
We have seen the S&P 500 move from 789 in March to 1000+ presently. Your stock selection process should not discredit stocks simply because they have doubled in a specific time frame. There is a possibility of them doubling again. If an identified stock doubles in a mediocre market, you should zero-in on that stock's forward-looking financial health and appropriate ratios from its balance sheets and income statements. If the most important fundamentals (ie, earnings and revenue growth at an exhilarated rate) are positive, the stock should continue to support itself and experience an upward pull.
Step 3 examines the "double-double" concept. This occurs when a stock doubles, regardless of the overall market's performance, and then doubles again. For example, if a stock moves from $30 to $60 and the market is roughly consistent, the relative strength of this stock would support the idea that the stock could double again to $120. The technical analysis applied in the overall evaluation process involves several considerations, including the support of the stock's trading price.
Investors can compare the double-double concept to Newton's Law of Gravity: A stock will continue moving north until a negative fundamental or technical force limits such growth. If a stock that doubled has inadequate relative ratios or anemic fundamentals, don't expect a substantial price drive. In that case, price/earnings (P/E) multiples, the lack of real earnings, and other signs of poor fundamentals can cause the stock to collapse. An eye on the technical analysis will allow you to sell this stock before there is a mass sell off.
Time to Sell Winners?
Back to the popular investor question: "Is it time to sell a stock?" The answer seems counterintuitive. Commonsense suggests that you shouldn't continue holding a stock that has drastically increased in value; you should sell it and buy something cheap. Thus, many investors avoid stocks with high prices in relation to their profit levels.
Investor's Business Daily
But a stock's P/E ratio is only one measure of evaluating how much you're paying for a stock. Craig Shaw of notes that highpriced stocks "tend to sport a loftier P/E than the rest of the marketâ€”even at the start of rallies. A high P/E means the stock is enjoying a strong demand. If that upward trend takes the stock near the breakout point of a sound base, it might proceed toward big gains."
If a stock has strong fundamentals and technical support, a savvy physician-investor should hold onto that position. However, if a stock increases signifi- cantly in value but lacks fundamental vigor, you should sell that stock.
There are limitations to technical analysis. Consult with an experienced advisor before applying it to your specific portfolio.
John Valentine specializes in portfolio management and in developing high-net-worth strategies. He is the principal investment advisor at Valentine Capital Asset Management of San Ramon, Calif. He welcomes questions or comments at 925-275-0200, or visit www.vcrpg.com. Securities offered through Securities America Inc, member NASD/SIPC, a registered broker/dealer.