Diamonds Might Be Forever, but Few Stocks Are

I dislike most stock-trading strategies, especially day trading, which I liken to betting on where a butterfly is going and when it's going to get there. The stock market should be simply about investing, because investing is about the noble endeavor of turning human capital into financial capital, and that requires years of commitment.

Yet that doesn't mean you have to hold a stock forever. Nothing is forever -- not you, not me, not even the Sun. Change is constant. Consider that more than half of the 30 Dow Jones Industrial Average stocks weren't components before 1991, and six of the stocks became components in 2004 or later.

Many investors speak of durable quality and staying power when they invest for the long term, but more often than not, they overestimate both items. A decade ago, for example, an investor could have persuasively made an argument for the durable quality and staying power of former DJIA members Eastman Kodak (NYSE: EK  ) , American International Group (NYSE: AIG  ) , and General Motors.

The history of the DJIA in particular and the stock market in general suggests that selling is not a consideration to take lightly, given the ephemeral nature of stocks' staying power. So when should an investor consider selling? Werner DeBondt and Richard Thaler noted in a Journal of Finance article titled "Does the Market Overreact?" that three years is a relevant time frame, based on Ben Graham's contention that the interval for a substantial undervaluation to correct itself was one-and-a-half to two-and-a-half years.

Speaking from a value perspective, I prefer a longer time frame, though -- one based on the ebb and flow of the business cycle. From 1945 through 2001, there were 10 business cycles, according to the National Bureau of Economic Research. The average time it took to get from the previous trough to peak was 57 months. I'm willing to give a company five years to right itself.

Of course, selling has its costs; nothing gets the teeth gnashing quicker than seeing a stock you sold double in price. Still, selling improves the odds of missing the sudden collapse of an AIG or a Bear Stearns and minimizing the damage of a slow, seemingly permanent descent of a Kodak. Both trips are often impossible to portend.

Selling also shields investors from those decades-long round trips. Of the handful of DJIA stocks that have been components for 50 years or more, three -- General Electric (NYSE: GE  ) , DuPont (NYSE: DD  ) , and Alcoa (NYSE: AA  ) -- are trading at 1995 levels.

In other words, if you are a long-term investor, it's worth vetting your portfolio from time to time. Consider selling issues that are becoming a little long in the tooth. The longer the times are good, the greater the odds they will turn bad.

Fool contributor Stephen Mauzy, CFA, holds positions in General Electric and DuPont. He's the author of the upcoming book The Wealth Portfolio, available this fall. The Motley Fool has a disclosure policy.


Read/Post Comments (1) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 13, 2009, at 10:36 AM, coveroad567 wrote:

    "seemingly permanent descent of a Kodak. Both trips are often impossible to portend"

    This is a quote from your article.

    Sorry, but it does turn out that Kodaks permanent decline was clear to inside observers at least 20 years ago. I did an interview with a Newsweek reporter in 1992 and made the argument that there was no business solution to the pending percipitous decline in silver haloid (film).

    That make sound crazy but to those of us who knew the business model which made Kodak the great compnay that it was for over 100 years could not be sustained much longer.

    Kodak, as it is and was known to us fondly is no longer. The 'yellow blood' that flowed through our veins has been relaced by normal red blood and the magnificent infrastructure built to sustain the model is gone forever.

Add your comment.

DocumentId: 963266, ~/Articles/ArticleHandler.aspx, 7/31/2014 5:28:00 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement