FOOL ON THE HILL
Never Too Late to Sell

If you own a "bubble stock" that may be heading toward zero, Whitney Tilson says you may want to consider selling it rather than holding on in the vain hope that you might recoup your investment. Looking critically at your holdings -- particularly hopelessly depressed ones -- can be difficult, but investors who bail on bad bets before it's too late may preserve both money and sanity.

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By Whitney Tilson
March 20, 2001

It's embarrassing to admit, but when I first started investing, I didn't have the foggiest notion of what I was doing. I thought I did, of course, but now I look back and thank my lucky stars that I didn't lose a lot of money, because by all rights I should have. Thank you Warren Buffett, Charlie Munger, Ben Graham, Philip Fisher and Peter Lynch, among others, for teaching me how to invest sensibly.

I'm going to tell you a story -- one I've never shared with anyone because it makes me look pretty silly -- in the hopes that some people might learn from my experience. It involves my most disgraceful investment, a sham of a company called Streamlogic. (Don't bother trying to find a web site or ticker, as it's long since defunct.)

I heard about the stock from a friend, who got a hot tip from her brother-in-law that it was going to be acquired for $14. The stock was going nuts on this speculation, rising in a matter of days from $1 to $6. I looked up the financials, which were a joke, but greed and ignorance caused me to buy 1,000 shares anyway.

You know where this story's going, don't you? I nailed the top and the stock declined relentlessly over the next few months. Every day I would look at my stock portfolio and there was Streamlogic, scornfully mocking me. It got depressing after a while, but I still didn't sell. Consumed by fatalism, I rationalized to myself that at $2 a share, it couldn't drop any further. And anyway, there was so little of my investment left that it really didn't matter, right?

One day I snapped out of my funk. I remember thinking, "Wait a second! $2,000 is real money! There are a lot of better things I can do with that money instead of watching it slowly evaporate." I had long since recognized that investing in Streamlogic -- at any price -- was a ghastly mistake, but I was compounding my initial folly by not taking immediate action to rectify the situation. So I sold, salvaging one-third of my original investment. (You won't be surprised to hear that the stock soon went to zero.)

The reason I'm telling you this story is because the emails I've received from my readers over the past few months lead to believe that there are many, many people in similar situations today. They made bad investments in preposterous companies, know now that they made a mistake, but haven't sold yet.

The truth about the Internet bubble
If you got caught up in the excitement over the Internet and made some investments you regret, learn from the experience and vow never to make the same mistake again, but don't be too embarrassed. There were very powerful forces at work that lured even the most sensible people into the party. Warren Buffett wrote about this in his recent annual letter to Berkshire Hathaway shareholders:

"Far more irrational still were the huge valuations that market participants were then putting on businesses almost certain to end up being of modest or no value. Yet investors, mesmerized by soaring stock prices and ignoring all else, piled into these enterprises. It was as if some virus, racing wildly among investment professionals as well as amateurs, induced hallucinations in which the values of stocks in certain sectors became decoupled from the values of the businesses that underlay them.

"The fact is that a bubble market has allowed the creation of bubble companies, entities designed more with an eye to making money off investors rather than for them. Too often, an IPO, not profits, was the primary goal of a company's promoters. At bottom, the 'business model' for these companies has been the old-fashioned chain letter, for which many fee-hungry investment bankers acted as eager postmen."

If you own the stocks of any of the sham companies that Buffett is referring to, I suggest that you consider selling them immediately.

Ah, but it's not always obvious which companies are shams, with stocks that are going to zero, and which are survivors, with stocks that might be good investments at today's low prices. How can you tell the difference? There are no easy answers and reasonable people will disagree, but let me give one example of the former: Loudcloud (Nasdaq: LDCL). This company's S-1 (IPO) filing reveals miniscule revenues, enormous losses, a mediocre (at best) business model, and future prospects that depend on taking market share from larger, established companies during a period when customers are retrenching. With no reasonable likelihood of profitability anywhere on the horizon, I can't figure out how Loudcloud is going to survive, much less thrive.

Whether or not Loudcloud eventually succeeds, it is clearly premature to take it public. Yes, hundreds of companies in similar situations went public over the past few years, but that was during a bubble that has now burst. In today's environment, this IPO is a travesty and both the management of Loudcloud and the underwriters, Goldman Sachs and Morgan Stanley Dean Witter, should be ashamed of themselves. Less than a week after going public, the stock is already down 20% -- well on its way to zero, where it probably belongs.

To sell or not to sell
My point is not that you should immediately sell any stocks you own -- whether Internet-related or not -- that have declined precipitously. Don't let yourself be frightened into selling a quality company because its stock price has fallen. In fact, you should be delighted by the opportunity to buy more of a stock you like at a lower price, all other things being equal.

Of course, all other things usually aren't equal. Maybe the company has missed earnings or announced bad news. Or maybe you now realize that when you bought the stock, you were counting on a greater fool to buy it from you at a higher price -- but you ended up being the fool.

My point, in the end, is that you should calmly and unemotionally evaluate every one of your holdings. Are there any in which you have lost confidence, or in which you still believe, but think the valuation is too high? Then think very hard about selling. The key question that I ask myself is: "If I didn't own this stock, would I buy it today?" If not -- and if there are no taxable gains -- then I will usually sell. (For more thoughts on selling, see my December column, To Sell or Not to Sell?)

As you review your portfolio, keep in mind that a stock doesn't know that you own it. Its feelings won't be hurt if you sell it, nor does it feel any obligation to rise to the price at which you bought it so that you can exit with your investment -- not to mention your dignity -- intact.

Conclusion
You can't change the past, but you absolutely can and should take actions today that will benefit your financial future.

After you cleanse your portfolio, then vow, as I did, to forevermore only own stocks in companies and industries you understand well, for which you believe the company and its management are of high quality, and that you can buy at an attractive price.

-- Whitney Tilson

Guest columnist Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. He did not own shares of the companies mentioned in this article at press time. Mr. Tilson appreciates your feedback at Tilson@Tilsonfunds.com. To read his previous columns for The Motley Fool and other writings, visit http://www.tilsonfunds.com/.