This Mistake Could Cost You a Fortune

Three great things happened in 2007:

  1. My shares of Transocean returned 78%.
  2. My shares of Freeport-McMoRan returned 89%.
  3. Oklahoma knocked off then No. 1-ranked Missouri in the Big 12 championship game.

But then disaster struck!
No sooner did I write a column virtually guaranteeing Oklahoma would take down West Virginia in the Tostitos Fiesta Bowl than the Mountaineers came out and utterly destroyed my team. (Not to mention that both Transocean and Freeport-McMoRan promptly took a nosedive -- along with the rest of the market.)

Now, my grandfather played football for Oklahoma, and I'm a diehard Sooners fan. So I'll keep rooting for them, even though they've lost their last four BCS bowl games.

You see, in sports, sticking by your team through the ups and the downs is a virtue. Just ask any Red Sox fan. Wall Street, though, is a different ballgame.

For proof ...
Just ask any "fan" of Crocs (Nasdaq: CROX  ) , Solarfun Power (Nasdaq: SOLF  ) , Ambac Financial (NYSE: ABK  ) , or US Airways (NYSE: LCC  ) -- all of which are down 45% or more this year.

Or ask Jim Cramer. In his book Real Money, he reminds investors, "This is not a sporting event; this is money. We have no room for rooting or hoping."

Yet it happens all the time. Investing message boards are full of desperate investors who hope some cash-rich behemoth like Intel or Google will come along and buy out their tiny niche tech play for a huge premium. For proof, wander on over to Yahoo! Finance sometime, and take a peek at the message board for Clearwire (Nasdaq: CLWR  ) .

Others ride stocks all the way into the ground because they're emotionally attached to the company's story, products, or management. Take Krispy Kreme (NYSE: KKD  ) for example -- down 94% since its heyday in the late summer of 2003.

Ditch that loser!
One of the "20 Rules for Investment Success" from Investor's Business Daily is to "cut every loss when it's 8% below your cost. Make no exceptions so you'll avoid any possible huge, damaging losses."

To a sports fan, that advice might seem cruel and unusual, but it's actually good investment advice.

Or is it?

To find out, I dug through David and Tom Gardner's Motley Fool Stock Advisor picks. They often re-recommend a stock even after a big run-up -- or a sharp fall.

In no time, I found three examples of when breaking IBD's rule paid off big time.

Stock Advisor Pick

Decline After Recommendation

Gain After Rerecommendation

Netflix

23%

200%

Dolby Labs

10%

94%

Quality Systems

14%

533%

These weren't flukes, either
In Tom Gardner's rerecommendation write-up for Dolby, he noted, "The stock has fallen 10%. Am I concerned? No. Am I thinking of dumping the shares? Hardly. I liked this stock then, and I like it even more today when it's a few bucks cheaper on no sustainable bad news."

Not only did he see no good reasons to sell the stock, but he also saw plenty of good reasons to own it. He noted "the company's strong brand, excellent financials, and long history of providing innovative audio entertainment technologies."

Result? A 200% gain
Similarly, David Gardner admitted, in his rerecommendation write-up for Netflix, "We're currently sitting on a 23% loss," but he went on to say, "I think this is one cheap stock at $11, backed by a great management team that's going to create value for us going forward."

Note that he, too, had well-thought-out reasons for owning the stock: "It remains first and best in a growing industry, creates convenience for millions of consumers, and is led by visionary management that markets aggressively." Netflix stock has risen 200% since then.

So when do you sell?
Some people have hard-and-fast numerical rules. Others -- like the Gardners -- stick to a more analytical and intellectual approach. It's a good thing, too, or else their Stock Advisor subscribers would have missed out on some massive gains.

When do David and Tom Gardner consider dumping a stock? Primarily when they encounter:

  • Untrustworthy management.
  • Deteriorating financials.
  • Mergers, acquisitions, and spinoffs that could damage the business.

The debate rages on
Someone once said, "I have no problem knowing when to buy a stock, but if I just knew when to sell, I'd be a great investor."

While investors may never agree on when or why to sell a stock, it's important to have an emotionless, well-thought-out strategy in place. If you don't, you may suffer major losses or miss out on massive gains.

For what it's worth, David and Tom Gardner rarely sell, and it works for them. Their average Stock Advisor pick is up 56%. Meanwhile, you'd be up only 19% if you'd bought the S&P 500 instead.

If your stocks aren't doing as well, they could be -- especially because you can join David and Tom at Stock Advisor for one month absolutely free. You'll get full access to their picks and stock research, and you'll even get insights on when to sell a stock ... and when to hold on to it.

About the only thing they won't be able to tell you is whether Oklahoma will ever be able to win another BCS bowl game. But hey, we already know the answer to that one ... I hope.

To learn more about this free, no-obligation 30-day trial, simply click here.

This article was first published on Dec. 28, 2007. It has been updated.

Fool contributor Austin Edwards owns shares of Freeport-McMoRan, Transocean, Google, and Clearwire. He dedicates this article to his grandfather, Summie S. Kidd. Dolby Laboratories, Netflix, and Quality Systems are Stock Advisor recommendations. Intel is an Inside Value recommendation. The Fool has a disclosure policy.


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