Frank Thoughts: The Sell Discipline
Frank Boland
July 25, 2022

It is always after a stock’s decline that one discovers the reason it had previously been going down. The more parabolic (straight-up) a stock’s previous assent has been, the greater the need for a sell discipline. If you’re an investor on your own, or are looking to hire a portfolio manager, you or they must have a SELL discipline. We certainly know this from the extent of declines occurring in the current bear market. The average stock is down 30%!  Percentage declines of 50%-90% are common. With such steep declines, if you do not have a sell discipline, your portfolio is going to be eviscerated.

Stocks that have risen parabolically during a bull market are the most dangerous in a bear market. Because of their previous success, hardly any existing holder can ever imagine the downside. This is true not only of existing individual stocks but of new popular investment concepts. Over fifty years ago, the popular concept was called The Nifty-Fifty. It didn’t matter what one paid for a stock in the grouping; they were all known as one decision (buy) stocks. Today, the modern version of this one decision concept has been known (note past tense) as FAANG and in its broader form … indexation.

The problem with a one decision stock - or even the concept - is that corporations have a bell curve just as we do. And like us, there is no way of ever knowing how long that life cycle will last. What we can know in advance is the life cycle of many – if not most technology companies - is considerably shorter than an RH Macy or Levi Struss. That was the reason Peter Lynch assiduously avoided most technology stocks. It is a lesson that Cathy Wood – the portfolio manager of ARK Innovation Fund - will yet have to learn.

There will be financial pain involved in her learning process.  22 years ago, I was with a client portfolio manager in his Boston office. At the time, we were primarily a research firm providing analytical work for institutional accounts. That year we had a major sell call on technology. Our work had convinced us the internet stock boom was over. This manager’s largest holding was Cisco Systems. It was the glamour stock of its day. During the tech bubble, it had gone parabolic. The manager’s response to being told it was a sell was, “You didn’t tell me to sell it at $70 (its high) it’s now $50 and I’m a buyer.” 

The portfolio manager was in his early 30s; I was in my 50s. “Please tell me what these companies have in common,” I asked. “Transitron, Microwave Associates, NCR, Data General, Prime Computer, Digital Equipment, Sanders Associates etc. His response was an honest, “I don’t know.” My answer was, “They were all within 20 miles of where we are, were leaders in their “space,” and not one of them currently exists.” Today, Facebook is trying to create a new business model {Meta) as is Google. Amazon is realigning its business model. Netflix has tremendous competition. Cisco Systems – the stock at the time - has survived, but its stock price is now less than it was that day 22 years ago!  

As Jim Cramer would say, “It’s not important where a stock has been, but where it’s going.” Apple facilitates communication much like Cisco Systems did … and still does. Its stock is in the bullseye of our Target Theorem. The theorem holds that weakness in a sector or industry will first show up on the periphery.  Weaker companies, such as the current unprofitable blitzscalers, are always the first to disappoint. They demonstrate weakness in their industry or sector. This weakness gradually moves to the center of the bullseye.  Apple is now the center of the bullseye, as was Cisco Systems 22 years ago.

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