Turkey Postmortem

By Selena Maranjian (TMF Selena)

(Nov. 24, 1999) -- Fools around the world will soon be staring into their refrigerators looking for something other than turkey leftovers to snack on. It's a perfect time to reflect on investing turkeys. (Come on... confess. You know you have some. We all do. Even Warren Buffett has admitted to several blunders.)

Some turkeys are companies you never should have invested in. Other turkey investments can occur with solid companies, if you sell their stock for a loss. A turkey postmortem should impart some valuable lessons. Here's how you might go about it.

First, examine your turkeys of yore. Make a list of all the stocks you've sold and the prices at which you sold them. Check and see how they're priced today. (This might be painful, so have some ice cream or cookies on hand for comfort.)

If most of the stocks have since recovered and are doing well, you probably should have hung on. Investors often jump ship prematurely, at the first inkling of possible trouble. Remember that many terrific stocks go through periodic slumps. America Online (NYSE: AOL), for example, has dropped by 50% on several occasions, only to recover. From 1990 to 1993, IBM (NYSE: IBM) lost two-thirds of its value, only to more than make up for that drop in recent years.

You should rarely sell a company just because its stock has fallen. If you're worried about a drop in its share price, take the time to find out what's going on. Make an informed evaluation of its growth prospects. See whether its troubles appear to have a fleeting or permanent nature. (In many cases, it's actually a good time to buy a stock after it's fallen. If you can determine that the market has overreacted and a company isn't in as much distress as most investors seem to think, then you may have found a great investment opportunity!)

But back to our postmortem.

Take note of how many turkeys you've sold. If you've got a big flock of them, you may have jumped into too many stocks without doing sufficient research first. If most of your turkeys are actually still in your portfolio, you've probably been putting off examining your holdings. Such due diligence is time-consuming but necessary. That's one reason why it's best to not own more than 10 or 15 companies -- it's hard to keep up with them all.

You should, at the very least, be checking up on most of your holdings each quarter, when quarterly earnings are reported. The closer you look and the more you dig, the better you'll come to know your companies. And the more familiar you are with a company, the less likely you are to encounter unpleasant surprises. For example, you might notice that inventory levels are growing more quickly than sales. Or that accounts receivable are outpacing revenues. Perhaps debt has grown rapidly. These are red flags that might help you get out of a stock before it sprouts feathers and a small bag of innards.

There are many ways to learn about what numbers you should be examining. Check out our How to Value Stocks area, for example. Pop over to the company's board in our message board area and see what people are saying about it. (And keep in mind that one or two quarters of disappointing numbers do not a disaster make. But it is cause for keeping closer tabs on the firm.)

If some of your holdings are in the red, you need to figure out if more patience is required or if you have a hopeless turkey on your hands. Think about why you're still holding. If you're simply being a patient Fool and are confident of the company's long-term promise, then you're all set. No need to worry. But -- perhaps you're holding on, just hoping to decrease your loss? If so, that reasoning doesn't fly. Imagine that you bought $5,000 worth of Year-3000 Solutions Inc. (Ticker: 3KFIX) and it's now worth $3,000. You realize the company has little merit and you're out $2,000. If you're waiting for 3KFIX to increase in price a little, to decrease your loss, that's probably a bad move. You may wait a long time and never see it happen. Instead, consider selling and moving that remaining $3,000 into a company you've studied and are excited about -- one where the $3,000 has a much better chance of growing. You need to consider the $2,000 loss as a sunk cost. It's gone. Focus on what's left and how best to deploy it. Remember: You want your money sitting in the most promising investments you can find.

One of the marks of a successful investor is that she takes the time to think about investing and to learn from her successes and screw-ups. An occasional turkey postmortem can be a very valuable exercise for any investor.

If you'd like to share an investment-gone-bad with Fool readers, visit the My Dumbest Investment message board.

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