Selling Petsmart, Buying Ecolab

Feb. 08, 2009 3:29 AM ETPETM, ECL2 Comments
Robert Freedland profile picture
Robert Freedland
55.35K Followers

Daniel Drew, a Wall Street financier of the late 1800's had a theory about stock market investing and stock trading. He commented about one of his strategies:

I ought to have [closed my position] without a moment’s delay - cut short your losses and let your profits run, is the rule.

This really isn't a bad suggestion. It is far better to sell losing stocks than gaining stocks, but is it the best approach? Can't gaining stocks turn into losing positions (vis a vis my own WMS sale Thursday)?

As I have worked on my own investment strategy I have developed my own philosophy, which is similar to Drew's, but perhaps has an interesting twist. I believe it is important to 'sell your losers quickly and completely and sell your gainers slowly and partially!'

I work very hard to select stocks of what I would call the highest quality. I anticipate that they will appreciate in price, yet I am prepared to limit their potential declines on the downside as well. In addition, I believe their actions are as much the fault of the market as my own poor investment selections!

Thus, when a stock declines and triggers a sale, I assume that there may well be something 'wrong' with the market environment and use that sale as a signal to 'sit on my hands' with the proceeds. Unless of course I am at my minimum degree of equity exposure, which, in that case, I still replace that holding, but with a smaller-sized position of another stock which should be equally promising. And when a stock appreciates to one of my own appreciation targets, I sell a small amount of that holding (currently 1/7th of the position) and use that sale as a signal that not only did I make a great pick, but also that the market is acting 'healthy' and it might well be safe to expand my own exposure to equities with a new holding.

Friday my PetSmart (PETM) shares hit one of those 'appreciation targets' and I sold 14 shares of my 104 share position. These shares had been acquired on November 20, 2008, at a cost basis of $15.58. My first targeted appreciation point is a 30% gain and with the stock trading at $20.47 Friday, I sold 14 of my 104 shares at that price and had a gain of $4.89 or 31.4% since purchase. This sale on the upside also generated a 'buy signal' for me and I went ahead and purchased shares of Ecolab (ECL).

Ecolab is an old favorite of mine. Most recently, I wrote briefly about this stock on December 13, 2008, talking about the things I like to see in a stock. But before I get to that, I wanted to discuss my latest approach to 'position sizing' within my portfolio management strategy.

Until recently, my position sizing was rather arbitrary. I thought about $5,000 for a position would be reasonable and then I purchased shares that hopefully were divisible by 7 to allow for a possible first sale. It was that bad!

My greatest challenge was determining what to do with positions when I got down to what I call my minimum size of portfolio--5 positions. That is, when one of my minimum 5 holdings hit a sale point on the downside and I needed to sell that holding, my strategy still required me to buy another stock to replace it. But replacing one position with another of the same size (or even larger) would still cause me to compound my losses in an unrelenting bear market that we certainly have experienced.

I decided that I needed to have some formula to select the size of my investment and since I still wanted to have five positions, the replacing position needed to be smaller to allow me to continue to reduce my exposure to equities even while maintaining the same number (5) of positions. I chose to replace holdings in my minimum portfolio with new stocks that were only 1/2 of the size of the average remaining holding.

But what about new purchases on actual good news? That is, assuming I am at 15 positions, and less than 20 (my maximum), how much money should I put to work when I get a buy signal (as I did Friday)?

My initial thought was to add new holdings equal to the average of the remaining stocks. But that wasn't aggressive enough. It could be possible that the size of the remaining holdings was quite small secondary to that extended bear market I discussed. Therefore, my current strategy is to continue to expand exposure to equities aggressively with 'good news' sales and purchase new holdings equal to 125% of the average of the other positions in the account.

And that is what I did Friday with Ecolab.

With my buy signal in hand, and that nickel burning a hole in my proverbial pocket, I purchased 134 shares of Ecolab at $35.4776 Friday morning. I have bent the rules recently, not requiring the new stock I am adding to my portfolio to be on the top % gainers list at all. That list is a great place to find new potential purchases and I continue to do so on my blog. But I am reserving the right to assemble what I consider the very best stocks in my portfolio, including all of the ones I have discussed in the past.

As I wrote this, Ecolab was trading at $35.73, up $.92 or 2.64% on the day.

Briefly, Ecolab was selected because of the solid latest earnings report, a great Morningstar '5-Yr Restated' financials, and reasonable valuation. I like the business they are in--"products and services for hospitality, foodservice, healthcare, and light industrial markets....", and like Sysco (SYY), I hope they are relatively recession-resistant.

Thank you very much for bearing with me as I reported on this trade and once again shared with you my own thoughts on dealing with portfolio holdings in as rational a manner as possible.

Disclosure: The author sold his shares of PETM and owns ECL.

This article was written by

Robert Freedland profile picture
55.35K Followers
Robert Freedland is a medical professional by trade and an amateur investor who has been blogging on Stock Pick Bob's Advice since 2003. He has been investing in the stock market for 46 years, having made his first purchase at the age of 13 of five shares of Global Marine in September 1967. He enjoys sharing his philosophy and perspective on investing, both by blogging and podcasting. Visit Bob's blog: Stock Pick Bob's Advice (http://bobsadviceforstocks.tripod.com/bobsadviceforstocks/). Since 2009, he has been managing portfolios on Covestor, which now include Growth and Momentum (http://covestor.com/robert-freedland/growth-and-momentum), Sustained Momentum (http://covestor.com/robert-freedland/sustained-momentum), Healthcare (http://covestor.com/robert-freedland/healthcare) and Large Cap Momentum (http://covestor.com/robert-freedland/large-cap-momentum).
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