Anytime we do a bit of spring cleaning in the portfolio—like the round prompted by February’s correction—I like to review our rules for selling.
We try to invest for the long-term in the Cabot Dividend Investor, but that doesn’t mean just buying, holding and hoping.
In short, there’s three things that can get a stock kicked out of the Dividend Investor portfolio:
- The Stock’s Trend
- Losses
- Fundamentals
Any one of these can be enough reason to sell, but in practice, most of our sales involve some combination of these failures. Here’s a more in-depth look at each of the reasons for selling a stock, followed by a look at some recent sales.
Reason #1: The Stock’s Trend
We have a saying at Cabot: “the trend is your friend.”
But the converse is also true: when trends aren’t in your favor, they can be your worst enemy. Now, we’re not trend followers to the extent of our colleagues over at Cabot Top Ten Trader or Cabot Growth Investor, but we still realize the folly of fighting against a major trend.
So, when a stock is trending down and shows no sign of stopping—when it’s slicing through moving averages and support levels—it’s time to respect the trend and get out.
Reason #2: Losses
While we aim to invest long-term and will ride out some corrections, losing a chunk of your capital up-front is harder to recover from than you think, and not always worth tolerating for the promise of long-term returns. Once your initial investment is depleted, your remaining capital has to work even harder to make up the difference.
For example, if you buy a stock and it then falls 40%, it has to go up 67% just for you to get back your original investment.
To avoid getting into such a situation, simply keep your losses from getting too big. We use a 15% to 20% loss limit on most positions.
Reason #3: Fundamentals
A change in fundamentals is usually a supporting criteria rather than a primary reason for selling, because most fundamental changes will be reflected in the stock price (reason #1). But it can still be an important factor in our decision to sell. Cabot Dividend Investor investments are chosen after careful consideration of a number of important metrics that affect the company’s ability to pay its dividend, longevity and growth potential. If a company’s fundamentals start to slip in any area, the stock is at risk of no longer earning its place in our portfolio. That could include declining IRIS ratings, a rising payout ratio, or red flags in revenue, EPS or free cash flow trends.
Recent Sales
We’ve sold two stocks over the past two months, based on changes in their technical strength, fundamentals, and our returns. Here’s a closer look at each of those sales.
Welltower (HCN)
We sold half our Welltower shares at the end of December, after the stock dropped definitively through support at 65 (reason #1), bringing our loss to 15% (reason #2). Plus, 2018 earnings growth expectations were declining as inflation expectations rose (reason #3).
We sold the rest of our shares in the first week of February, as interest rates anxiety reached a fever pitch, the stock continued to fall and our losses continued to mount. The stock has fallen about 8% further since our final sale. Even if this is the bottom, the damage done means HCN won’t be a leader of the next market advance.
Wynn Resorts (WYNN)
Non-financial factors can also contribute to our decision making. After The Wall Street Journal published claims that Steve Wynn serially sexually harassed his employees in late January, the stock immediately fell 20%. We sold half our shares at that time, mostly because of the uncertainty created by the allegations and the related investigations, and the likelihood of subsequent analyst downgrades (reason #3). We sold the rest of our shares last week, after the stock failed to bounce during the market rally, demonstrating a lack of buying power (reason #1).