Diagnosing a stock’s health

So what happens when you have a sick stock in your long-term portfolio?

When I say sick, I don’t mean a stock that is crashing – that scenario may prove fatal, unless it is as a result of an overall market crash, in which case the market is sick, not your stock.

What I am referring to is a stock that is stagnating; it’s been drifting in your portfolio for at least two or three years, paying dividends but not moving higher. 

Firstly, as always, don’t panic. This happens and may not be a worst-case prognosis – it could just be the flu. Over the last couple of years, the market as a whole has done little and many stocks have followed suit.

The reality is that stocks go up, they go down and sometimes they go sideways, which can go on for ages.

With a stock that is experiencing a sideways range, one should not worry; three years is a blip on the radar when compared to a lifetime of investing that will span decades.

However, it is still important to check if you’ve erred in your selection, and consider whether you should exit the stock.

The first thing to do is assess how its peers on the JSE have been performing. Are they soaring, crashing or also going sideways?

If they’re also stagnating, this could indicate a sickly sector, and it would be wise to investigate the sector as a whole. The sector could be in decline (like our local steel industry) in which case an exit may be the best route.

Or perhaps it got well ahead of itself and the sideways move is just the share price waiting for earnings (and valuations) to catch up.

The latter has occurred in the retail space over the last couple of years to a degree, and many of the stocks are still off their highs. In this case the valuations had gone crazy, so they needed a rest.

But if it seems to be solely your stock that is suffering, you need to start digging deeper. Find the initial notes you made when you bought the stock for the first time.

Were your assumptions and expectations realistic? Have things changed? Did you expect something to happen, which hasn’t come to fruition? If it hasn’t, why not? Were you wrong or too early?

Basically, go and revisit all your theories about the stock that attracted you to it and ensure that you were right and that they still apply.

Things also change with stocks and that element that made a stock great may no longer be present.

So check it against its peers. What’s happening to the margins of the competition versus the margins on the stock you hold? Are they under pressure? Is it the entire sector or only your stock? Is your stock losing market share? (Check like-for-like ex-inflation growth, for example.)

I find industry publications and websites can sometimes be useful for doing some digging on these sorts of issues. Of course be careful as industry organisations may only be sharing the good news.

Check to see if any merger or acquisition activity occurred, which may have moved the marketplace in favour of, or against, a particular stock.

A competitor conducting a significant merger or acquisition may have had a negative impact on the stock you’re holding.

Alternatively, perhaps your stock conducted a deal, for which it overpaid, or the synergies weren’t as great as management promised.

Essentially, you need to go back to the beginning and start afresh. Review everything about the stock and if at the end of the process you’re still happy to hold it, then hold.

Don’t worry about a few years of lacklustre performance. If you’re not happy, then exit and find a new awesome stock to own.

This article originally appeared in the 16 June 2016 edition of finweek. Buy and download the magazine here.

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