Investors love the chase: The intellectual exercise of researching a company, following the trends, analyzing the numbers. I imagine it's like stalking big game in the jungles of Africa; hacking away at the underbrush to track the obvious and subtle trail of your prey. And when the hunt is over, there is an immense sense of satisfaction in mounting a new name into your portfolio. But unlike a stuffed trophy on the wall to be admired, the work of the stock safari is from over. For as an investor, your post-purchase role has changed from hunter to zoo keeper, and few find long-term pleasure in mucking out the corporate cages.
Balancing Intellect and Emotion
Investing is a balance of intellect and emotion. Most investing decisions are weighted toward the intellectual side of the brain. Investors on the hunt have no ties to some cold, faceless corporation. But once we connect a piece of ourselves to the name, the game is changed.
Beyond simply having skin in the game, we've laid our intellectual reputation on the line. If the stock price falls, a sale would signify and memorialize a wrong decision. (Who wants to be wrong?) If the stock is sold for a profit, how can you be sure you haven't left profits on the table? (Who willingly walks away from bigger gains?)
Imagine my pride in garnering a short-term 30% gain on a mega-cap stock. Cash in hand!
When the stock pulled back, validating my move. Loss averted!
But as 30% gains were quick-trigger misses on a stock which doubled - investment angst? Only slightly. The stock profits pocketed came compliments of Apple (AAPL). In the short 16 months from Nov. 2010 to March 2012, Apple stock doubled to over $600 per share, and has announced its plans for a dividend. Another tech name delivered 50% gains to investors during similar calendar dates from Sept. 2010 through Feb. 2011. But capturing that price appreciation from Research In Motion (RIMM) would have created no angst, as that stock plummeted from $69 to near $12 in the ensuing 12 months. Two tech stocks. Two solid gains. Two different emotional responses.
Three Questions; Three Answers
There are myriad sets of criteria for buying a stock, but I'll suggest every investor needs to answer three identical questions: Why did I buy it? Why do I hold it? When will I sell it? I'll further recommend that these questions need to be answered before the purchase trade settles. These questions don't discriminate between growth stocks or dividend holdings.
Johnson & Johnson (JNJ) is a dividend aristocrat, having shared profits with shareholders at an annually increasing rate for nearly 50 years. Why buy it now? Among other reasons, it's trading off the 52 week high and growing earnings. Why hold it? Solid dividend history and its yielding more than 3.5%. When will I sell it? One answer: when it increases 8% above my purchase price within the next 6 months. That level will net me more than twice the annual dividend in a short period. If it doesn't hit that level, I still hold the stock for the dividend.
A mature tech version of this scenario can be found with Intel (INTC). I'll consider picking up some shares because it's trading in my buy range. I'll hold the shares because of its commitment to paying dividends and I'll sell the shares if its earnings show steady decline and/or its board stops raising the dividend. The importance, here, isn't what my buy/hold/sell criteria is. The importance is found for ALL investors documenting the intellectual answers to these three simple questions. Investors will never be consistently successful if decisions are based on what they think - leave that power of divination to the spirit mediums. No, successful investors will decide up front, the profits they desire and the losses they won't tolerate. AND then, they'll act upon those decisions with no sense of angst or remorse. Big game hunters may forever admire those trophy heads collecting dust on the wall, but few investors would allow those annual reports of Enron or Worldcom to collect similar dust on their mounting frames.
The above article has been written utilizing data from publicly available sources, which are believed to be reliable, and is provided for informational and educational purposes only. Investors should consider their personal situation and become intimately familiar with any investment, including its prospectus, before investing. Past performance and current yields are no guarantee of future results.
Disclosure: I am long JNJ.