Avid gardeners look to the coming summer as a time to tend to their patch of earth – harvest the ripe, nurture the growing, or yank the weeds.
It’s also a good time for investors to take advantage of lower trading volumes and do some portfolio gardening. Toron Investment Management reviews client portfolios in much the same way to spot the stocks that have reached their potential and should be sold, those that require more patience, and the losers that should be plucked.
“At least twice a year we try to go through all the different assumptions that led to the initial valuation and the original decision to purchase the stock, and make sure that everything we thought still applies,” says Toron partner Karl Berger.
For stocks that have gained in value, Toron looks at how their prices compare with the company’s earning potential. “We look at the valuation to see if the evolution of the business continues to support the stock price it’s trading at,” Mr. Berger says. If the price is consistent with or below earnings, it likely stays. If it outpaces earnings, Toron brings in the harvest.
Mr. Berger says India-based ICICI Bank is one example of a stock that was ripe for the picking. The stock nearly doubled in value from when Toron purchased it in 2005 to November of 2011 when it was sold. Over the next six weeks it fell 37 per cent. “You basically had to assume the Indian economy was going to grow at low double-digit rates for the next 20 years to justify the valuation that was required for ICICI to be trading at that level,” he says.
Canadian National Railway, on the other hand, is an example he uses as a stock that has gained but has more room to grow. “There’s never been a reason to sell it, even though the price has gone up, because the underlying business has continued to evolve.”
In some cases Mr. Berger says he will prune part of a position in a stock that has grown if it begins to dominate a client’s portfolio.
Dealing with a stock that has lost value requires some soul searching and a degree of humility, according to Mr. Berger. “When stocks go down you have to be really vigilant to see if the premise you purchased the stock on still exists or whether it ever really existed.”
One option is to admit you were wrong and sell at a loss, he says. Another is to reassess. One stock that got a second chance in the Toron portfolio was Japanese PVC pipe-maker Shin-Etsu Chemical. The stock was purchased in November of 2007 on the eve of the U.S. housing meltdown. When it lost half its value by the following March a decision was made to hang on. In less than two months it regained half its value and has since surpassed its former high. “It was a sound company with sound fundamentals but we got the timing wrong initially,” he says.
However, when good stocks go bad he has a warning for investors looking to buy more. “The notion of averaging down just to reduce your cost base I think is folly. But if you have a business that was solid and for whatever the reason the entire market as a whole has traded down for reasons that are unlikely to affect the performance of the company, then it’s fine to rebalance that position back up to a neutral weight.”
He recommends the same sort of evaluation when stocks flounder in a narrow trading range and uses Microsoft as an example. The stock hardly budged from mid-2010 to 2012 but it managed to grow its dividend yield to nearly 3 per cent. “They were making cash hand-over-fist and doing exactly what we wanted them to. The market just wasn’t recognizing it for whatever reason.”
Toron’s nurturing investment style isn’t for everyone, though. When it comes to tending the portfolio, Barometer Capital Management portfolio manager and head trader Diana Avigdor says it’s survival of the fittest. “Our basic tenet for our investment strategy is: Keep your winners, dump your losers.”
Barometer grows the winners and snips the losers by placing trailing stop losses below a stock’s current market price, which triggers a sell on the first whiff of a decline. “We only buy stocks that are on an upward price pattern. We buy on the way up and we sell on the way down,” Ms. Avigdor says.
Her disciplined investment style is exemplified by Apple, which she initially bought in the $500 range and let a stop loss trail it up to around $700. When the stock retreated to $600, a sell was triggered. At one point she even shorted Apple to the $400 range until another trigger got her out of position. “If it starts being the best performing stock again we may get back in,” she says.
What about good stocks that go bad in a broad market drop? She says natural-gas provider Keyera is an example of a hardy stock in her portfolio that gets knocked down by market winds and keeps getting back up. “Over the last few years we got shaken out of it – once when it was not performing relatively during the financial crisis,” she says.
The flounderers that trade in a tight range are often spared from Barometer’s heartless stop loss. Ms. Avigdor says the big Canadian banks are a good example where basic analysis – and a bit of compromise – are required.
“It would behoove you to take some profits as it moves lower but not sell out the whole thing because there is still a fundamental reason to hold it … so cut it in half. You can always get back.”Report Typo/Error
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