Ottawa Investment Advisor John Bruce

World Economy Shows New Growth

May 27, 2010 · Print This Article

Major indexes have been hit hard in recent weeks on worries of European sovereign debt problems.

Here are some points to help calm investor angst, courtesy of Avery Shenfeld, chief economist with CIBC World Markets. “While you weren’t looking, there has been some good news from that trivial economy known as ‘the world excluding Greece, Spain, Portugal and Ireland’” he wrote in his weekly report Friday.

  • Canadian employment and retail sales have risen sharply,
  • Real gross domestic product outlook for the first quarter is close to 6 per cent,
  • Corporate earnings have exceeded expectations both here and in the U.S.,
  • Companies are raising their dividends,
  • Falling oil prices will boost consumers’ spending power,
  • Japan’s GDP exceeded 4 per cent for the second quarter in a row
  • Germany posted a 4 percent rise in industrial activity.

Reasons to Sell

In the event you are wondering how to react to sell-offs and market scares, I thought it would be good to review when and why you should sell your stocks, if you are a long-term investor and not a market timing, quick trade gambler.

Provided that a share of stock is bought at a reasonable price, there are only a few reasons to sell it.

1. Analytical Error, or Material Change

If upon buying shares, you later conclude that errors were committed in the analysis which fundamentally affect whether the business is a suitable investment – then you should sell even if it means a loss will be incurred. In addition, there could be a material change which fundamentally affects the analysis of the business as a suitable investment. The key to successful investing is to rely on your data and analysis instead of Mr. Market’s emotional mood swings. If that analysis was flawed for one reason or another, move on. Sure the stock price can go up even after you sell, causing you to second guess yourself, but the key to successful investing is to learn from mistakes. Everyone will make mistakes.

2. Rapid Price Appreciation

It’s very possible that the stock price, for one reason or another rises dramatically in a short period of time. The best investors are the most humble investors. Don’t take such a quick rise as affirmation that you are smarter than the overall market. Indeed, one’s chances of making money in the stock market over the long run increases significantly if you buy cheaply. But a cheap stock can become an expensive stock in a very short period of time for a host of reasons, some of which are likely due to speculation by others. Take your gains and move on. Even better, should the shares decline later, you may be presented with the opportunity to buy again. If the shares continue to increase, the worst that happened was that you took a profit!

3. Valuation is No Longer Justified by the Price

The value of any share of stock ultimately rests on the present value of the company’s future cash flows. Valuation will always carry a degree of imprecision because anything in the future is uncertain. A good rule of thumb is to consider selling if the company’s valuation becomes significantly higher than its peers. Another more reasonable selling benchmark is when a company’s P/E ratio significantly exceeds its average P/E ratio over the past five or 10 years. For instance at the height of the Internet boom, Wal-Mart shares had a P/E of 60 times earnings. Despite Wal-Mart’s quality, any owner of shares should have sold and potential buyers should have looked elsewhere.

The Bottom Line

Selling is bad when it is dictated by emotion instead of data and analysis. Remember not to judge your selling by whether or not you are selling at the top. Instead focus on selling for reasons dictated by rational reasons of valuations and price.

John S. Bruce
Ottawa Investment Advisor
Also licensed in ON, BC, AB, QC, NS
Mackie Research Capital
Direct Line- 613-425-3732
Toll Free- 866-860-4190

The opinions, estimates and projections contained herein are those of the author as of the date hereof and are subject to change without notice and may not reflect those of Mackie Research Capital Corporation (“MRCC”). The information and opinions contained herein have been compiled and derived from sources believed to be reliable, but no representation or warranty, expressed or implied, is made as to their accuracy or completeness. Neither the author nor MRCC accepts liability whatsoever for any loss arising from any use of this report or its contents. Information may be available to MRCC which is not reflected herein. This report is not to be construed as an offer to sell or a solicitation for an offer to buy any securities. Member-Canadian Investor Protection Fund / member-fonds canadien de protection des épargnants.

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