A question that I often struggle with, particularly with downtrodden, value-oriented stocks, is whether to sell companies that haven't achieved expected financial progress. Intellectually, the decision is a no-brainer. If the company doesn't meet projections, it's out the door. On the other hand, human nature often says no. Selling at a loss forces me to admit a mistake, which is never a pleasant task. In addition, company management almost always says it's just around the corner from turning things around. My mind wants to buy into the argument and hold "just a little longer," particularly if a stock looks cheap.

Over the past couple of years, I've become much better at selling companies when events aren't materializing like I expected. In a hypothetical online value/turnaround portfolio that I've maintained online for the past 15 months, I've dumped five holdings because their progress disappointed me. Although just a few months have passed since making those decisions, I'm currently much better off having sold when I did. The only thing that would have improved my performance was selling earlier or doing more due diligence before the initial purchase.

The following table shows how the stocks I've sold performed while I owned them and how they have done since my sell. You can get a little more color on the situation by looking at my reasoning for buying and selling the stocks, which is summarized at the bottom of this article.

Stock            When Held  Since Sell  
Avado Brands       -15%        -79%          
Int'l Flavors      -19%        -17%
Ionics             -16%        +11%
Sunterra           -66%       -100%
Sports Authority   -54%        -39%
(Pause for laughter about the horrible performance of these stocks while they were held. My only minor defenses: They're my worst performers, and we're always learning.)

Ignoring the abysmal performance while the stocks were held, the most important thing I see in the above table is that my sell decisions were good ones. Three of the five stocks have fallen 39% or more since the sell date, including one that went into bankruptcy. Another stock dropped 17%, while only one increased in value.

Believe it or not, I actually had difficulty making most of those sell decisions. My mind kept saying that the companies would turn around. Stocks like Sunterra, Avado, and Sports Authority looked so cheap relative to their book value and/or earnings opportunities under "normal" circumstances. Nonetheless, fundamentals and stock performance continued to deteriorate at most of the companies.

Looking at stock performance two to eleven months after a sell decision was made on only five stocks can hardly be considered scientific. Nonetheless, this anecdotal information shows it can be advantageous to sell companies that are fundamentally not poised to achieve their long-term objectives.

Even though a stock might look cheap on a price-to-earnings or price-to-book basis, very little will keep it from becoming cheaper if company performance worsens. You can bet that I'm going to closely scrutinize my losers in the future, selling when long-term fundamental performance seems impaired.

Color commentary on buys and sells:
Avado Brands (Nasdaq: AVDO)
Buy (5/18/99 @ $8.75 per share): This company, formerly Apple South, has divested all of its franchised Applebees units to focus on its own proprietary brands. The company owns Don Pablo's, McCormick & Schmicks, Hops Restaurant and Brewery, and Canyon Cafe. Performance at some units has been erratic, but the company is selling at only 12x earnings estimates for the year. This story could prove interesting as the company focuses only on its proprietary units.

Sell (9/7/99 @ $7.41 per share, a 3-month, 15% loss): It may be premature to dump Avado, but I think it is the right move to make. The company's debt load has become excessive, now standing at $286 million, up from $117 million last year. in addition, the company has convertible preferred of $115 million outstanding. In comparison, shareholder's equity is $119 million and the company's market capitalization is about $200 million. With such a high debt load and deteriorating results at the Don Pablo's brand, I don't think it makes much sense to stay in the stock.

Current: $1.50 per share, down 79% during the 11 months since I sold. The company's performance has continued to stink.

International Flavors & Fragrances (NYSE: IFF)
Buy (5/18/99 @ $39.50): A turnaround situation on which I might be a little early. The company has not grown earnings since 1995, but it is still one of the dominant firms in providing flavors and fragrances to manufacturers worldwide. The balance sheet has no debt and the company is a profuse generator of cash. We will enjoy a 3.8% dividend yield while waiting for international markets to bring about a return to growth for this company.

Sell (6/16/00 @ $32, a 13-month, 19% loss): The latest earnings warning from International Flavors and Fragrances is the last straw for me. I've been ignoring financial warning signs from the company for several quarters because of my enthusiasm for its business model (nearly 20% pretax margins, strong cash flow) and international exposure (67% of sales, almost 80% of profits). No more. The ominous signs that local-currency business is below expectations rubs me the wrong way. Sales have been stagnant for at least three years, and the company needs to get them growing again to achieve success. It doesn't look like it's poised to achieve that in the intermediate-term. Finally, and most importantly, the company's balance sheet is in a free fall.

Current: $26.38, down 17% over the past two months.

Ionics (NYSE: ION)
Buy (5/18/99 @ $33.25): Another turnaround story. This company, which makes systems for and provides services related to water treatment, was hammered by last year's downturn in the semiconductor industry. Despite this setback, the company is a leader in an industry that seems poised for a bright future as water treatment becomes increasingly important.

Sell (3/2/00 @ $27.88, a 10-month, 16% drop): Although I still believe strongly in the prospects for water-related businesses, I'm not convinced that Ionics is the company to rely on. When purchasing this company, I was expecting a rebound in Asia and that the microelectronics business would help boost the company's prospects. This macroeconomic bounce occurred, but Ionics hasn't participated. Earnings were down this year and the company warned they could fall again this quarter. In comparison, companies like Millipore are reporting strong revenue and earnings growth.

Current: $30.88 -- up 11% in the five months since the sale.

Sunterra (NYSE: OWN) -- no longer listed
Buy (5/18/99 @ $11.94): This is the leading independent timeshare company in the nation. It is enjoying the phenomenal growth in the timeshare industry. While the financial structure of the industry has left many professionals leery, Sunterra has set up successful conduit facilities to help finance receivables. The company currently trades at about 8x estimates for 1999.

Sell (1/21/00 @ $4.00, a 66% plunge over eight months): As you may or may not be aware, the stock has plunged more than 60% this year. Today it announced that fourth-quarter earnings were going to fall well below forecast and it is taking a charge of $38MM-$45MM related to balance sheet assets -- primarily delinquent receivables. While today's announced charge-off (which basically wipes out all earnings for the year) may not legally be fraudulent, I view it as serious management misrepresentation and don't want to have any more exposure to the company's problems.

Current: Filed for bankruptcy on 5/31/00; the stock is no longer listed and is basically worthless.

The Sports Authority (NYSE: TSA)
Buy (6/4/99 @ $4.88): The Sports Authority is the nation's leading sporting goods superstore. I'm interested because the company seems to finally be reigning in inventories, which were down 2% on a comp-store basis last quarter. The company does have a bunch of debt ($255 million vs. $273 million in equity), but it signed a new $200 million revolving credit agreement in April that removes concern about a liquidity crisis. The company's book value is about $8.50 a share and analysts are guessing that TSA will earn $0.34 this year. I figure it's worth a shot, at less than 65% of book value with signs of a turnaround from footwear manufacturers and management looking to return to profitability.

Sell (10/25/99 @ $2.25, a 54% loss in five months): When I purchased the stock in June, I felt the company had a decent chance of a turnaround, with several underperforming stores closed last year and a new supply management system in the works. On top of that, the footwear companies (particularly Nike) indicated a turnaround was afoot, leading me to believe TSA may have seen its worst days.

That obviously was not true. Earlier this month, the company announced that its loss for the current quarter would be in the range of last year's, much worse than analysts and I were expecting. This basically indicates that, despite the changes that were implemented, business conditions are not improving. In many ways, they are deteriorating.

Current: $1.38, down 39% in the 10 months since the sale.