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Michael Bowman is a portfolio manager at Wickham Investment Counsel Inc. in Hamilton.
What are we looking for?
There is very little research on the subject of when to sell a stock, yet it is a crucial skill for investors to master. Today, we'll look at two sell signals that you may want to monitor.
The screen
My colleague Allan Meyer and I looked at Canadian companies that have reported earnings since the beginning of August, searching for firms that are displaying a couple of sell signals that we follow in our own portfolios.
The first signal is a significant decline in the trajectory of earnings. A seven percentage point or larger decline in quarterly earnings momentum often comes ahead of a fall in the stock price. (The quarterly earnings momentum is defined as the last four quarters of earnings compared with the previous four quarters of earnings.)
The second signal is analysts lowering their earnings estimates. We consider it a sell signal when the median estimate for this year's profit is 15 per cent, or more, below the same estimate from three months ago.
We excluded the oil and gas and real estate sectors from our screen since those evaluations should focus more on cash flow.
What did we find?
Eighteen companies in our data base exhibited both sell signals. This doesn't mean that these companies are doomed to see their share prices sink. But, in our opinion, it does suggest that investors may want to take a close look at whether their rationales for holding their shares still hold water.
On a broader level, this screen illustrates the need to be as disciplined about your sells as you are about your buys. You should have a well thought out process for identifying stocks that are becoming less attractive to hold. Not every sell decision will be correct, but setting firm criteria for what you're prepared to hold can limit losses. Investors should always know where the exit is, and how to get there.