As we approach the one-year anniversary of the market bottom on March 9, 2009, it's high time to review our portfolios to consider which stocks we might sell.
The market has gained 63% since its nadir, and nearly all of the companies in the S&P 500 index have produced positive dividend-adjusted returns. If you had the fortitude to invest in just about any stock in those dark winter months, you're likely sitting on nice gains today.
What's more, those gains are now over a year old and qualify for the lower long-term capital gains tax rate. While some of your stocks will be worth holding longer, with market values harder to come by today, now may be the time to take some profits and raise cash.
If the two bubbles and bursts of the past decade taught us anything, it's that a profit is a true profit only when you sell. Many of us have seen paper gains vanish in just a matter of months because we simply held too long. Avoiding a repeat performance sounds easy enough, but deciding exactly what and when to sell is the challenge.
For one, you have enormous social pressure to keep holding during a rally. As former Citigroup CEO Chuck Prince told the Financial Times in 2007 about the private equity boom, "as long as the music is playing, you’ve got to get up and dance." It was psychologically easy to sell when everyone seemed pessimistic about the market in 2008 and 2009, but now that the market has rebounded, investors are once again putting money into equity mutual funds, and the tenor of news headlines has changed, the fear of selling too soon and missing more upside has become real once again.
At the end of the day, though, it's important to remember that the point of value investing is to buy 80-cent dollars and sell them for $1 or more. Only in extremely special situations will you sell 80-cent dollars for $10 and get to do a victory lap around your living-room computer.
Pruning the hedges
While lower-quality stocks with shaky balance sheets led the early part of the rally, a number of higher-quality names have picked up steam as the market recovery has matured and should also be considered for sale today. Warren Buffett, for instance, recently trimmed positions in high-quality companies like Procter & Gamble (NYSE: PG ) , Johnson & Johnson (NYSE: JNJ ) , and ConocoPhillips (NYSE: COP ) to allow the Berkshire Hathaway (NYSE: BRK-B ) portfolio room for other opportunities, even though he still believes in those stocks’ long-term upside.
It's in a similar vein that I suggest it's time to sell some of your Apple (Nasdaq: AAPL ) shares, which are up nearly 150% over the past year, to explore other opportunities in the market.
For one, Apple doesn't have the high-growth potential it used to. After all, it is a $190 billion company, and a double in price from here would make it $70 billion larger than ExxonMobil (NYSE: XOM ) and $130 billion bigger than Microsoft (Nasdaq: MSFT ) today. Yes, it's possible, but it seems improbable -- at least anytime soon.
As any company grows larger, it becomes increasingly difficult to increase sales and profits at the same rate as in the past. For Apple to increase sales 10%, for instance, it needs to add about $4.7 billion in new sales this year. Again, it's possible, but it's certainly not easy to attract such gargantuan sums, and it won't get any easier as the company grows.
Nevertheless, the stock is priced as if the good times will continue, with the median analyst long-term earnings growth estimate at 18%, according to Capital IQ. The Wall Street bunch seems to have reached a consensus that Apple is a "buy" today, with 34 of 39 rating it either "buy" or "outperform" versus one "sell." Meanwhile, short interest has crept higher and is at its highest point since April 2009.
Again, none of this is to say that Apple doesn't have more good years ahead of it -- it's a quality stock with a stellar balance sheet, after all -- but if it makes up more than 10% of your portfolio after its run-up, it's time to take some of your capital out of the investment and reallocate it into other opportunities down the road.
Ring the register
In today's market, where just about every asset class has rallied over the past year, it's important to have some cash on hand in case the market drops a bit. There's simply no substitute for being able to pounce on great values; that means either adding fresh cash to your brokerage account or taking some profits from your winners.
The next step is to review each of your current positions and your valuation estimates. If a stock now exceeds your estimates and makes up a large portion of your portfolio, it's time to take some money off the table.
One stock our Motley Fool Inside Value team has expertly navigated since 2007 by sticking to its valuation estimates is Cimarex Energy (XEC), an oil and natural gas exploration and production company. The team first recommended the stock in February 2007 for $35; they sold in April 2008 for $63.15 -- a 79% gain. They then recommended Cimarex again in March 2009 at $24.31 and cashed in at $54.99 -- a 126% return -- in January. Sure, the stock's since increased to $60, but there's absolutely nothing wrong with locking in two very profitable trades.
To learn more about Inside Value's valuation methods and other recommendations, take a free 30-day trial of the service by clicking here. There's no obligation to subscribe.
Fool analyst Todd Wenning is living too much in '82 and owns shares of Procter & Gamble and Johnson & Johnson. Berkshire Hathaway and Microsoft are Motley Fool Inside Value recommendations. Apple and Berkshire Hathaway are Motley Fool Stock Advisor picks. Johnson & Johnson and Procter & Gamble are Motley Fool Income Investor recommendations. Motley Fool Options has recommended a buy calls position on Johnson & Johnson and a diagonal call position on Microsoft. The Fool owns shares of Berkshire Hathaway and Procter & Gamble and has a disclosure policy.