We usually cut 1-3 stocks per quarter when they run out of steam, the fundamentals deteriorate or some external development takes them off the table. Exit activity lately has been on the active side, so it's worth a refresher course on our sell logic and how the math is holding up.
First things first: We're never happy when any stock we recommend loses money. It doesn't happen often, but about 10% of the names we've introduced over the last 18 months have gone the wrong way. When all the evidence tells us a retreat is more a matter of a bad swing in the market's mood pendulum than a concrete problem with the company, we hold on. After all, a stock that drops for irrational reasons can just as easily rebound when sentiment turns.
However, when the fundamentals deteriorate, there's no reason to assume that sentiment will recover before the operating metrics themselves improve. This is simple math. If a stock cycles between (for example) 10X earnings and 20X earnings depending on the market mood, a 5% decline in earnings still argues for a 5% lower price.
Quite a few investment propositions depend on earnings getting better and not worse. If the growth trend flattens out or reverses, that story no longer represents reality. And that kind of eroding trend is unlikely to beckon a lot of buyers unless there's a good reason to suspect the glitch is transitory. Most investors will wait for the first hints of recovery, which they review on a quarter-to-quarter basis when earnings come around. As a result, a stock that falls on earnings might bounce a little, but it's unlikely to go far for at least three months.
Stocks going nowhere rarely make a lot of money or move fast to recover lost territory before they can get back to work. While we hate locking in a loss, we know that a clean break liberates cash to seek more dynamic opportunities.
If the options are hanging around in a dead-money position for months (exposed to further downside), or migrating to a stock that's got a little sizzle, we'll take the faster horse every time. The only exception is when we have high conviction that the position isn't dead money at all. When it's obvious that the market doesn't understand a great company, we'll wait for that big light bulb to click on. Otherwise, there's no point in flipping the switch over and over hoping that something different will happen. We did this with Twilio and even Facebook and they have turned out quite well.
The recent earnings season gave us an occasion to cut all the dead switches from our universe. In all cases, the story changed, cutting through all rumor and hope. Sometimes BMR subscribers cashed out with a big profit. Other times, we'll have to score the position as a loss. That's the price we pay for being in the market and, like everyone else, not being able to forecast with 100% accuracy which companies will rise and which will fall.
Over the long haul, however, the losses recede in the rear view and get lost in the wins. Unlike a lot of investment newsletters that take profit early and often, we let our winners ride as long as they're still doing well. (Apple, Google, Shopify). We extend almost as much patience to the stocks that don't take off immediately. Maybe they need weeks or months to reveal the potential we saw at the beginning. Once in awhile, that potential fizzles and we cut them loose.
Over the last 18 months, BMR exits have averaged a slight positive return . . . Your return depends on the stocks you personally buy, but in general, it's been enough to cover the downside. That's including the latest wave of sells and remarkably, it's beaten the S&P 500.
If we wanted to inflate our returns, we could easily harvest one or two of our extremely appreciated recommendations. (Close to a dozen BMR stocks are up 100% or more since we initiated coverage.) We don't do that because we see additional upside there. It's not our style to cash out when the future still looks bright.
But it's nice to see that even counting the stocks we cut this quarter, the overall BMR universe is up 49%, moving up at an annualized rate of 27% year after year. The losses recede. The wins keep stacking. (If this doesn't align with your experience, let us know. We'll do what we can to get you on a more bullish track.)
And as of now, we love all remaining stocks in our portfolios. They survived another earnings cycle having either matched our expectations or given us compelling reasons to wait another quarter. And outside the Aggressive portfolio, which is always going to be extremely volatile, only a few of our Sell Prices are in play right now.
Square (SQ: $66, up 6% this week) and Spotify (SPOT: $135, up 8%) cracked their Sell Prices late last year because we raised our sights right before the 4Q18 Technology selloff. The businesses didn't decline and as recent performance shows, they're currently racing to recapture their peaks. That's no reason to sell.
Bristol-Myers Squibb (BMY: $46, up 2%) is a trickier case. We've waited a long time for Wall Street to appreciate this company, but we won't hold out forever. If the looming Celgene merger doesn't turn the trend around, it will be time for tough choices. For now, however, earnings are good and for once investor reaction matched the numbers.
Office Properties (OPI: $24, up 2%) took ages to recover its $22 Sell Price but as the ramifications of the company's recent merger become clear we suspect the worst is over. Now it's time for shareholders to start working their way back, one beat at a time.
And if you're still hurting from any of our recent sells or simply running out of patience, go ahead and take a little profit out of a winning position to refresh your cash balance. Statistically speaking, you must have one or two BMR stocks that's up 40% to 400%. If not, again, let us know. We want you to win.