The Hard Work of Selling Losers

 
The Hard Work of Selling Losers

Three Reasons to Sell

Chinese Kids Online!

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The Cabot Market Letter's market timing indicators turned positive last week. And it will take only another good day or two for the Cabot China-Timer, the timing indicator I use to determine the stance for the Cabot China & Emerging Market Report, to flip to a buy signal.

So right now, despite the week's sag, things still look pretty good for equity markets, and you should actively work on your watch list and narrow down your buying selections.

Toda,y however, I'm discussing selling. I know this may sound a little counterintuitive, but I assure you that I have good reasons.

The main reason is that, after many years of communicating closely with literally thousands of growth investors, I know that many of you have a few rotten apples in your growth portfolios.

("Rotten apples" is a polite euphemism for the harsher term I usually use to describe the failed stocks that accumulate when investors don't follow their sell disciplines.)

Sometimes these are stocks that used to be big winners, but have deteriorated from heroes to villains over the years. I've talked to a few people who are still holding First Solar (FSLR), which they bought at well over 300 in May 2008, but brings just 123 a share now. First Solar was a huge winner for lots of people during the brief flowering of solars in 2008, and a few investors just can't let it go. And First Solar is just one of many.

Most examples aren't quite that dire, but many growth portfolios accumulate losers, both big and small, for several reasons.

I'd like to write about three, in hopes of convincing you that a thorough housecleaning can do both your investment performance and your investing attitude a lot of good.

Reason One: It's a $50 Stock!

If you buy a stock at 50, it's a common mistake to assume that your buy price is the logical and correct value for the stock. So when the stock plummets to the high teens, you persist in thinking about it as a $50 stock. And nobody wants to sell something worth $50 for $19. So you hold on from a combination of stubbornness, denial and anger.

Your rational mind will probably tell you that your intransigence is a crock, but it's still a powerful urge. Listen to your rational mind.

The market doesn't give a bucket of warm compost for your notion of what a stock should sell for. The chart that shows the price of your stock is a continuing record of a collective decision made by millions of people putting millions of dollars to work on that subject. You don't have to like it, but if you ignore the market's decision because you bought higher, you're just wrong. Get over it. Sell the stock.  

Reason Two: It Might Come Back.

One big rationalization for holding onto a big loser is that it might come back.

This isn't completely wrong, because obviously some stocks actually do come back.

If you look at the chart for Crocs (CROX), which soared to 75 on Halloween in 2007, you'll see a sickening 13-month decline that took the stock to within an eyelash of penny stock territory in November 2008. CROX spent 18 weeks building a bottom at about 1.5 after that crushing decline, then began to show renewed life in April 2009. After a long, fairly steady slog higher, the stock is now trading near 27.

If you had bought at the peak and held on, your stock would now be worth nearly 36% of what you paid for it. And you'd still be holding, refusing to give in to mere reality.

You would also have wasted three years and nine months of your life with your money tied up in a losing stock, with all the lost opportunity that involves. Yes, you want to make your money back, but you don't have to make it back on that stock. And while you hold on, you haven't been able to put that money to work in stronger growth stocks.

You won't ever get that lost opportunity back. Sell the stock.

Reason Three: It's Not a Loss If I Don't Sell.

This one isn't rational either, but I suspect that it's sitting in the back of some people's minds when they refuse to cull their losers.

Maybe it's the blow to the ego that you have to absorb when you finally admit that your decision to buy didn't work out.

Maybe you have just decided to ignore the loss, regard the money as lost and fall back on Reason Two.

Listen to me. If you bought at 20 and the stock is at 10, you have exactly half of the capital that you had before. It's not 20 with an asterisk. It's not a theoretical loss or a paper loss. What you can sell it for today is exactly what it's worth. It's just a loss.

It happens to everyone. We have a word to describe people who never suffer losses in the stock market.

We call them liars.

If you can't take the occasional loss, you should be in index funds with an investment horizon of 20 years or more. Then you can tell yourself that the losses don't exist. You'll still be wrong, but it's easier to rationalize that way.

I'm leaving out a few other reasons people don't sell, including I Really, Really Love This Company; My Father Left This Stock to Me; I Just Can't Stand To Think About It; and I'd Feel Really Foolish If I Sold and the Stock Went Up the Next Day.

But the moral is clear. Growth investing is like gardening; if a plant isn't flourishing, you need to dig it out of your garden. Flowers may be romantic, but great gardeners are about as sentimental about their plants as killer whales are sentimental about seals.

If it's a loser, sell it. Your growth portfolio will thank you.

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For those of us who grew up on books and records, there has always been something a little creepy about television and video being used as baby sitters. But there it is. I'm sure that the ready availability of Disney movies, Bob the Builder videos and on-screen friends from purple dinosaurs to big yellow birds and beyond has saved many parents' sanity and lots of family car trips.

In China, one company is on the cutting edge of the online edutainment for children business, and that's Taomee Holdings (TAOM). Taomee was founded in 2007 by veterans of TenCent Holdings and clearly has its sights set on dominating the market for the attention of Chinese children between the ages of five and 15.

Taomee's main asset is its website www.61.com, which offers online worlds for kids to play, interact and meet people. With 27 million in its online user base (online fees produced 94% of 2010 revenue), the company has already shown that it can use characters from 61.com to produce tie-in books, TV shows and toys. Two books based on online characters have already cracked the bestseller list for kids in China.

Taomee is building a platform that can spin off products into many areas, and both revenues and earnings are ramping up quickly. Q1 results featured 150% earnings growth on 90% revenue growth, and both results represent a cooling off from earlier performance. That's the advantage of a short history. The other genuinely impressive number is the 73.6% after-tax profit margin booked in Q1.

TAOM came public in June, and made headlines mostly because the stock failed to blast off at all. In fact, it slipped slightly from its open at 9 to close its first trading day at 8.2. But since then, TAOM has shown some power, building a short base at 10 for a few weeks, then lifting off a few days ago on heightened volume. It's now trading at around 13, and will bear watching, especially if the broad market can shake the dust off its shoes.

Right now, the only thing lacking in TAOM is a long enough history to give a clear picture of how investors feel about it. And time will supply that.

Sincerely,

Paul Goodwin
Editor of Cabot China & Emerging Markets Report

Editor's Note: Click here to learn more about other top emerging markets stocks recommended by Cabot China & Emerging Markets Report, which was the #1 ranked newsletter for five-year performance in 2009 and 2010 with a total return of 174%. Don't miss another five years of monster growth! Get started today.

Paul Goodwin can be found on Google Plus.

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