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Investment Ideas Have = Expiration=20 Dates

28-Jan-02 11:50 ET

[BRIEFING.COM - Robert V. Green] You probably wouldn't drink = milk in=20 your refrigerator that is a month past the expiration date. Why = are you=20 still holding on to the stock whose investment idea has expired? =

Stock Purchase Premises

We believe strongly that when you buy a stock, you should have = an=20 investment premise.

A premise is an reasoned explanation or idea for why the stock = price=20 for your chosen investment will rise. This includes ideas such = as:

Revenue and earnings will grow because the company has great = distribution in an expanding market.=20
The company will be acquired because it fits well with XYZ's = stated=20 expansion plans.=20
The company will continue its strong demonstrated increase = in its=20 net profit and gross margin percentages, thereby earning an = increased=20 market multiple.=20
The company's market multiples are low in comparison with = comparable=20 companies, and will eventually reach parity.=20
The historical stock price chart indicates a coming change = in the=20 stock price.=20
A new product introduction will generate a new stream of = revenue and=20 earnings that are not yet factored into the price.=20
The company is the sole provider of a product, demand for = which will=20 increase.

These are examples of the conclusion of an investment premise. = A fully=20 developed premise includes a financial projection and assumed = market=20 multiples in the future that predict the future stock price.

(For the moment, we will ignore the problem of buying a stock=20 without an investment premise. This far too common practice = deserves its own separate treatment.)

Even the best researched and thought out investment premises do = not=20 always come true. How you address your investment at this moment = is a key=20 element of investment success.

Sell When It Does Not Work Out

An investment premise imposes a discipline upon the buying = decision.=20

It also can be a key element of the sell decision.

When it becomes clear that an investment premise is = wrong, you=20 have only two choices:

Sell.=20
Develop a new premise.

Failure to take either of these two paths means that "hope" is = now the=20 premise on which your money is invested. While "hope" is a great = motivator=20 in our emotional lives, it is a very poor reason to make an = investment.=20

When you learn or decide that your investment premise is wrong, = and you=20 cannot develop a new investment premise, you must sell, even if = it=20 means a loss. Failure to take losses at this point only = subjects your=20 money to "uncalculated risks." If you have no reason for why the = stock=20 price will rise, you have no understanding of what is driving the = stock.=20

As an extreme example, consider Exodus Communications. The = investment=20 premise behind many owners of the stock in 1999 and 2000 was that = the=20 world-wide boom in web site build-outs would lead to an increased = customer=20 base for Exodus with strong revenue growth and earnings growth. = This was=20 actually a very reasoned and rational investment premise at the = time.

However, this investment premise was destroyed in April = of 2001,=20 when Exodus reported sequential revenue declines were coming. At = that=20 point, the price of the stock was $9. Investors who had bought on = the=20 growth premise were faced with large losses. The stock had traded = above=20 $50 just six months prior and $100 one year earlier. [Katherine's note--technical sell rules got you = out of this=20 stock *long* before the fundamental slowdown kicked in. If you = missed the=20 technical sell rules, the lone fundamental rule of slowing=20 earnings/revenue would have saved you.]

But anyone who sold EXDS at a loss in April 2001 because the = growth=20 premise had been disproved, saved the additional $9 a share = they=20 would have lost if they continued to hold the stock.

"Avoiding investment loss" is the same as "making money." When = you sell=20 at a loss because your investment premise has not worked out, you = often=20 save yourself from further losses. [Katherine's=20 note--another CANSLIM sell rule, cut your losses short and move=20 on]

Expiration Dates

Investment premises have expiration dates.

If you have strong investment discipline, you can sell when you = know=20 your investment premise is wrong. But what if time elapses and = there is no=20 conclusive evidence that the premise is either right or wrong? = What then?=20 [Katherine's note--think this is an = investing=20 discipline that transcends all styles]

You should decide, in advance, how long you can wait for the = premise=20 upon which you based your investment decision to develop. Patience = may be=20 a virtue, but investment patience that is not backed up by = progress=20 eventually becomes "hope" and not a true premise.

Business progress towards a business goal is called "traction." = If your=20 premise is based upon a company's business fundamentals you need = to look=20 for traction in the earnings reports. Failure to produce traction = is often=20 a contradiction of a growth premise, even if the company's stock = price=20 does not move. You should decide how long it "should take" for the = business to truly live up to the promise of your premise. If = traction=20 doesn't occur in the timeframe you expected, start = considering=20 selling.

This is the reason that growth stock prices decline so = drastically upon=20 poor earnings reports. Disciplined professionals dump the = stock=20 when their premise is disproved by poor results. The refuse to = hold the=20 stock, even if the losses are severe. [Katherine's=20 note--another important sell rule...inexplicable gaps down near = earnings=20 dates and/or gaps down on earnings news.....get out of the way. = Another=20 sell rule--tails near the top on high volume indicate = institutional=20 selling...pay attention and make sure you have big ears when the = market=20 speaks.]

If your investment premise is based upon technical analysis, = expiration=20 dates are even easier to define. Most TA approaches forecast chart = moves=20 within a timeframe. When it turns out that the expected turn did = not=20 happen within the timeframe expected, your investment premise = has=20 expired! [Katherine's note--another = sell=20 rule...if a stock breaks out and has not follow-thru within a = reasonable=20 timeframe, move on]

New Premises

When the milk in your refrigerator expires, you pour it out and = get a=20 new gallon. The same practice should apply to investment premises. = [Katherine's note--another CANSLIM principle, dump = the=20 losers, pyramid into the winners. If your sell rules kick in and = there is=20 nothing of quality setting up to buy, you wait in near-cash. = If you=20 are more aggressive you can practice "upside-down CANSLIM" and go=20 short.]

It is extremely distasteful to take a deep drink of sour milk=20 unknowingly. Equally unpleasant is holding a stock long after the = reason=20 you bought it has been explicitly disproved through contradiction, = or=20 implicitly disproved through the absence of traction. Only you can = decide=20 how long your investment premise should last, but without an = expiration=20 date, you may well find that your investments have curdled while = you=20 weren't looking.

Comments may be emailed to the author, Robert V. Green, at rvgreen@briefing.com =