Managing A Stock Portfolio Through Times Of Great Change: The Sell Decision
Especially in times of significant uncertainty and change, portfolio management can seem a whole lot more like a journey than a destination. Neither Warren Buffett’s “my favorite holding period is forever” nor John Maynard Keynes “when the facts change, I change my mind” provide adequate nostrums for action. If one’s investment reaction times lag fast changing events on the ground, as is the case with myself, there is going to be a soul-searching period of what to do next. Yogi Berra’s “when you come to a fork in the road, take it” seems a much better guidepost than either Buffett or Keynes.
So with a raging pandemic, an upcoming national election, high unemployment, uncertain trade policies, unprecedented Fed actions, a significant shift to working and shopping on-line as well as a number of other variables, how does one navigate the stock buying and selling rapids, keeping in mind that investing strategy depends largely on one’s personal circumstances. This article assumes that you have already made your asset allocation decisions among cash, high quality fixed income investments, stocks, annuities and the like.
In my own case, I am a rather cautious and methodical retired person who has enough income outside of my stock portfolio to sustain my life style. I am willing to take some risk but am very conscious of Warren Buffett’s first rule of investing: “Don’t lose money.” Most of what I make in the stock market will most likely end up with the next generation or with charities. So it is within this context that this article evolved, and it addresses only the portion of the portfolio that is in stocks.
Navigating The Decision To Sell
Though not generally recognized, making a decision to sell a stock is really much harder than making a decision to buy or hold. This is especially true in a general market collapse. Most of us know that fear is an extremely strong emotion and are reasonably careful to guard against it by falling back on Buffett’s adage about a forever holding period. And many people have had the experience of selling and then coming to regret it. We believe that things will come back and in the aggregate they always have. However, this is a very different proposition than believing the same things will come back. Unfortunately, we also anchor. We get stuck in what we think, what we know and what we believe, even after things change to make our opinions, beliefs, and knowledge obsolete. We also tend to endow things we already own with more value than they actually have and have a decided loss aversion—believing that if we don’t sell, we haven’t really lost anything.
If one looks at the stock market over the last few months, one can see how this quagmire of behavioral tendencies can cloud judgment. What fell is not principally what came back. If one looks at the S&P 500, which is about flat for the year now, this is abundantly clear. Of the top ten stocks by weight in the index, only one is negative year to date—you guessed, it Berkshire Hathaway (BRKB). Microsoft (MSFT), Apple (AAPL), Amazon (AMZN), Facebook (FB), Google (GOOGL) are all double-digit wonders to the upside, with Amazon being up over 60% year to date.
One need only contrast the high flyers to what happened to some mall and shopping center REITS, many retail businesses, airlines, restaurant chains, major integrated oil companies, fitness centers and the like to see that what is happening is not so much general collapse and recovery but more appropriately considered an acceleration of already occurring macro trends and a tectonic shift. While the extent of the shift may be arguable, there is little doubt that the world has changed.
So how does one make the decision to sell, while taking the behavioral stuff out of the decision process. It should happen through a reasonable analysis of triggering events, macro changes in the environment, or loss of a value proposition.
- If a stock loses its value proposition, one should consider selling. For instance, an income stock that dramatically cuts its dividend is no longer of significant value for one who bought it as an income stock. A growth stock being disrupted by a competitive technology change, such as what happened with Nokia (NOK) or Blackberry (BB), may also be a candidate for sale. If its value was in its growth and it is no longer growing, the sell decision should be fairly obvious. The point is to have very conscious value proposition for what you own.
- If a stock is significantly on the wrong side of some macro trend, say a shift to e-commerce from bricks and mortar or the movement to green energy and away from coal, one should consider selling. Or if the supply-demand relationship changes as happened with oil in 2015, there may be a good case for selling.
- If a stock has declined more than its peers or risen less than its peers in the same business, one should consider selling unless there is a compelling strategic reason why this is so.
- If a stock has declining earnings or negative results with other key metrics over some significant period of time, one should consider selling.
- If one comes to the conclusion that their initial analysis missed some major point or was flat out wrong, then they should consider selling. The internet bubble was a classic example of people refusing to do this until way too late. Animal spirits not analysis ruled the day and as John Bogle pointed out “When there is a gap between illusion and reality, it is only a matter of time until reality prevails.” It took more than ten years for the NASDAQ to recover from its delusions.
- If in a corporate spin-off, one of the entities is left with out sized debt, pension liabilities, legal or environmental liabilities, declining business lines etc., the weaker of the stocks is a candidate for sale.
- Likewise, mergers and acquisitions need to be examined carefully, especially when a company takes on significant financial liabilities or integration challenges to make them happen. The marriage of two sub-par managements rarely results in a superior company. Many studies have concluded that the majority of mergers and acquisitions have decreased rather than increased shareholder value. However, this is by no means a clear sell signal as there are often strategic opportunities present also.
None of these conditions or events, fall into the category of market timing. When one owns stocks that are just generally moving with the market, it is not time to sell unless one clearly has the superior crystal ball. I do not. One needs to be particularly careful of articles written by Dr. Hindsight featuring what Nassim Taleb calls “retrospective predictability.” In fact, if you have solved your asset allocation questions, none of the above is even a rationale to lower market exposure but rather a rationale to change what one is exposed to in the market.
To Err Is Human – To Err Really Badly Takes A Special Talent: The Case Study
I am pretty sure when they establish the company “Mistakes R-US” I will be in line for the CEO position. Back at the end of January, it was clear that I had bought into the notion that the “Retail Apocalypse” was over stated. Over the period of about a year I had accepted that, between new and experientially oriented properties, malls and to a lesser degree outlet centers were on the verge of a comeback. Basically, I discounted the force of e-commerce and the number of retail bankruptcies occurring. I also liked significant dividend yields and did not distinguish well enough between dividend growth companies and high yield dividend companies.
Many stocks in the high yield category have high payout ratios against earnings, funds from operations, or distributable cash flows. This equates to significant risk as even a small or temporary change in one of these metrics can result in a significant dividend cut. Also, in some cases, companies have high yields because their underlying business and stock price have been in decline. Back in late January 2020, 2.8% of my portfolio was in a combination of Tanger (SKT), Simon (SPG), Macerich (MAC), and Service Properties Trust (SVC). I sold all of these at a considerable loss and reinvested the funds. They possessed multiple of the criteria for selling but most conspicuously were on the wrong side of macro trends, lost their value proposition with regard to income, and had seriously declining metrics even before the pandemic. Arguably they may come back significantly but I deemed it unlikely that they would come back fully or quickly—and possibly not at all if there is a wave of bankruptcies. One cannot help but notice that many proponents of these stocks are now practicing a lot of revisionist social distancing.
Likewise, at the end of January, I had positions in three major integrated oil companies Royal Dutch (RDSA), TOTAL (TOT), and Chevron (CVX). Combined they constituted 2.7% of the portfolio. RDSA and TOT are gone now as again their profiles fit multiple sell rules. They were sold at a relatively smaller loss than the REITS and the funds reinvested. CVX is a much longer term holding, still at a significant gain position in the portfolio, and to my thinking the best of the international integrated oil companies. It bears close watching however. And I had a significant position in Ladder Capital (LADR), another high yield stock, whose metrics deteriorated significantly and it cut its dividend. This too was sold at a significant loss and the funds redeployed.
And there were some stocks I sold that had decent gains though not enough to offset the losses in other areas. Mostly these is sales were based on what I perceived to be a change in their risk profiles from when I bought them. Some of this is obvious as with Boeing (BA) and the 737Max and scarcity of airline orders. Some is much less obvious as with the environmental liabilities associated with Dow (DOW). And some sales are certainly debatable. I sold McDonald’s (MCD) in part because of its Pandemic and China exposure but also because of the shift in consumer preference to fast casual. Again, however, I did not take the funds out of the market.
The biggest mistake I made was not what I owned but what I did not own. I was very light on tech and new economy stocks. I did not own MSFT, GOOGL, FB, AMZN or other large new economy stocks. This failure muted the participation in the rebound. Proper weight to macro trends would have prevented this.
To React Appropriately Is Not Divine – But It Is A Lot Better Than The Alternative
So does my portfolio look like now? What did I buy and just as importantly what remains to be done? The portfolio as it stands is grouped and weighted as follows.
- 13.11% In Broad ETFS—Vanguard S&P 500 (VOO), Vanguard Dividend Appreciation (VIG), Vanguard High Dividend Yield (VYM)
- 12.32% is in Financials—Canadian Imperial Bank (CM), Royal Bank of Canada (RY), Toronto Dominion Bank (TD), Wells Fargo Preferred Series L (WFC-L), Aflac Insurance (AFL), Travelers Insurance (TRV), Truist Financial (TFC), Ares Capital (ARCC), Sixth Street Specialty Lending (TSLX)
- 6.10% in Energy—Chevron (CVX), Phillips 66 (PSX), Oneok (OKE), Enbridge (ENB), Kinder Morgan (KMI)
- 7.01% in Utilities—Duke Energy (DUK), Exelon (EXC), Pinnacle West (PNW), PPL (PPL), Southern (SO)
- 23.83% in Health Care and Health Insurance—AbbVie (ABBV), Amgen (AMGN), Merck (MRK), Pfizer (PFE), Abbott Laboratories (ABT), Baxter International (BAX), Johnson and Johnson (JNJ), Stryker (SYK), Anthem (ANTM), CVS (CVS)
- 8.29% in Communication Services—AT&T (T), Verizon (VZ), ViacomCBS (VIAC)
- 3.48% in Technology—Cisco Systems (CSCO), Intel (INTC)
- 3.01% in Transportation—Norfolk Southern (NSC), Union Pacific (UNP)
- 4.71% in Retail and Consumer—Home Depot (HD), Target (TGT), Pepsico (PEP)
- 13.31% in Real Estate—Medical Properties Trust (MPW), National Health Investors (NHI), Physicians Realty (DOC), Iron Mountain (IRM), Plymouth Industrial (PLYM), WP Carey (WPC)
- 4.27% in Industrials—Deere (DE), Dover (DOV, DuPont (DD), Genuine Parts (GPC), Magna International (MGA), Waste Management (WM), 3M (MMM)
- 0.56% in Other—Corteva (CTVA), Hasbro (HAS)
Though I have exposed my mistakes, I have done some things well over time also. The portfolio is a work in progress, but there are some decent things about it. Even with the sale of some of the high yield stocks, it still spins off a significant amount of cash. It yields 4.22% on the market value of the stocks and 5.43% on their basis. It contains a number of high-quality dividend growth stocks, many of which are long term holdings. And though I see this year’s losses as a major hit, the unrealized capital gains in the portfolio still exceed those by a factor of about 7.
The high number of health care stocks carries significant policy risk but has performed over the last five years on about a par with technology stocks. And the two long-term holdings in retail, Home Depot (HD) and Target (TGT), as well as the two long-term holdings in transportation, Norfolk Southern (NSC) and Union Pacific (UNP), have done well and will most likely continue to do well. They are clearly not a mall-based department store or an airline stocks. And four of the remaining real estate stocks (MPW, NHI, DOC, and WPC) I have high confidence in as well as all of the utilities. Further, a number of the stocks have actually increased their dividends this year to include JNJ, PEP, TGT, KMI, and ENB. So what has changed from what you would have seen in January 2020 besides the sales decisions?
- The broad-based ETFs were significantly increased – VOO so that I could capture more of the momentum behind technology stocks and VIG to enhance my position in high quality dividend growth stocks. Honesty compels me to admit that if I had invested in these two ten years ago, I would have had considerably less income but probably more wealth. The index-based ETFs constantly reward stocks that have increasing prices and buys less of those that don’t. That is dynamic that is hard to beat—bless you John Bogle.
- With regard to individual stocks, I started positions in Merck (MRK) and Pinnacle West (PNW) and added to positions in HD, DUK, SO, KMI, OKE, RY, and CVS. In general, you will notice that I favor Canadian banks over US banks. Historically, they have been much more stable, have not cut their considerable dividends, even during the financial crisis, and not required bailouts. They have a much better relationship both with regulators and their society than US banks. They are always rated by independent bodies as among the safest in the world, which is definitely not the case with US banks.
- You would also notice that I added to the pipeline stocks, though the additions were small. Pipelines with a large amount of their income from take-or-pay and fee-based contracts have a very different risk profile and value proposition from those companies with a large commodity exposure. And they have a significant moat around them.
- I still do not have the technology exposure I should have. If there is a pull back, I will increase the exposure to large cap technology stocks significantly. What has stopped an immediate shift is that so much of their recent price increases have been based on valuation shifts rather than earnings increases. MSFT recently closed at $208.75, with a PE of 34.78. Back in 2014 MSFT’s high was $50.00 and it had an average PE of 14. While the earnings increase in MSFT has been great, a little more than doubling in the last six years, much of the price increase is due to increased valuation. Since I missed the first train, I will wait for the pull back. And many technology or new economy stocks are not nearly as solid as MSFT and have never seen a profit. Some of the methods for valuing them have a distinctly Year 2000 feel about them. Or maybe, I am just not smart enough to evaluate them.
Portfolios are and should be dynamic without being chaotic. The two stocks I think I have the least handle on in the portfolio are AT&T and Plymouth Industrial. Yet they both still have significant weights in the portfolio. AT&T is the poster child for bad acquisitions, has several declining business lines, has enough debt to finance most countries, and with a new CEO, may forget that its value proposition for most investors is its yield. It triggers some significant sell criteria. Plymouth Industrial is a fast-growing REIT in the right business line, industrial properties, but has just cut its dividend and has some opaque finances with regard to its Series B preferred stock. So, I need to do some deep thinking about these two stocks. If technology stocks get a more acceptable valuation in my eyes, T and PLYM could become a source of funds.
Sell decisions are the toughest most investors will have to make. They involve all manner of behavioral trap doors and the decision discipline around them is not nearly as well defined as for buy decisions. There are, however, some events and conditions that should really trigger a close look. I have suggested a starting list of those. Nothing is really forever. And constant percolation is not good either. There is no perfect portfolio as uncertainty is always with us. But if one can separate the behavioral issues from true analysis, tuning a stock portfolio to meet one’s value propositions and needs can happen.
Disclosure: I am/we are long VOO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am long all the stocks listed with the percentage identified subgroups