In our Saturday column, we discussed the difficult issue of whether to sell a losing stock -- particularly one that has been in the cellar for a protracted period -- and gave our criteria for when we favor holding on. We cited Archer Daniels Midland (ADM), a name that we recommended in mid-May, as an example of a losing stock that we believe meets the criteria of not only being held, but also one that deserves a larger position.
Today we look at the other side of the coin: when it makes sense to sell. Selling losing or dead-money stocks is, of course, painful. However, oftentimes absorbing the current loss is likely to be the better alternative if the following hold true.
1. Your original investment thesis is no longer valid, and/or the competitive landscape is significantly different from what you had originally anticipated.
2. Based on the latest information and results, a company's issues are deeper and take significantly longer to address than you had anticipated.
3. You have not already owned the stock -- and, presented with the current state of affairs, you would not become a new buyer.
4. Management does not seem to be addressing problems with any sense of urgency, and they shouldn't have a focus on shareholder value over the near and intermediate term.
5. There is little or no likelihood of an outside catalyst.
6. Balance sheet and financial strength isweakened as a result of weak earnings, weak cash flow, or the company's leveraging up its capital structure.
If a number of these considerations are present when reviewing a stock that is lower than your initial investment price, you might want to consider selling and moving on.
A recent example of a losing stock that we think deserves to be sold is Staples (SPLS), another name that we had recommended in that same above-linked May article. Like ADM, Staples also sells at the low end of its valuation range and is statistically cheap. However, we are reaching a diametrically opposite conclusion and have sold our Staples position.
We've based that on the following.
● There's a more muted outlook caused by a slower-than-expected U.S. economic recovery -- the timing of the turn keeps getting pushed out.
● We're seeing continued concerns about Europe and the company's inability to proactively right size its European operation during the continent's prolonged recession. The more time we have spent chatting with the company and analysts about Europe, the more difficult and costly it seems that it will be to fix in the current environment.
● U.S. Staples stores have suffered recent weakness vs. the company's competition. That contrasts with the past few years, during which Staples has fared much better than its competitors on in-store sales trends, so this is a new and troubling development.
● Finally, there's been an unexpected slowing in the company's online business -- also a recent development.
To add insult to injury, after five to six quarters of below-expectation earnings and outlooks, management stated on its mid-August earnings call that, as a result of the weak quarter and outlook, the company would engage in a strategic review to downsize the business. The results should be forthcoming in the next quarterly report.
While that's a step in the right direction, from our perspective it's too little, too late. It also lacks a sense of urgency or any concern for Staples shareholders. These issues have been front and center for the past year, and the company has been consistently pressured on this subject by shareholders and analysts. As a result, we are very frustrated that it has not only taken the company so long to face the issues, but also that it would require an additional three months to figure out a remedial game plan.
We also have concerns that certain required adjustments for Europe might be very costly, and that these could stress the company's balance sheet.
From current levels, we think Staples shares will probably be OK and presumably could rise significantly higher if and when the company gets its act together. But this could take a lot more time than we originally envisioned, and the stock carries more risks.
Bottom line: We think there are likely better places to make more money much sooner.