Don't Sell A Single Stock Before Checking These 5 Signs

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The S&P 500 is on fire. Theindex is on track for its ninth consecutive month ofgains . And chances are anystock you've owned in that time has risen at a respectable pace as well.

Yet one thought is gnawing at many investors: Is it time to think about locking in profits? 

After all, we're already past the point wherestocks saw substantial pullbacks in recent years. And thisyear 's surge is even more impressive than the surges we saw early in 2010, 2011 and 2012.

S&P 500: A Surge, A Swoon And A Surge Again

Yet even if one chooses to start selling stocks, it's not always clear which candidates in your portfolio are ripe for jettisoning. Here are five guideposts I look for tospot potential sell candidates.

1. Portfolio Concentration
If you aim to construct a portfolio with an equal weighting given to all stocks, you'll notice that the weighting changes over time, thanks to varying levels ofappreciation . 

That hot stock that once accounted for 5% to 7% of your portfolio might have grown to 15% or more today. That's too much. The problem with these heavilyweighted stocks is that they can wipeput your gains more quickly in amarket pullback. 

As a handy exercise, calculate the size of each position in your portfolio. Any holding that is now worth more than 10% of your total portfolio is worth re-examining in the context of these guideposts.

2. Balance Sheet Trends
While most investors fixate onincome statement trends, most notablysales andprofit projections, they should really look to the balance sheet for signs of concern. For retailers, you want to see if inventories are rising at a fast pace -- especially as a percentage of sales. Let's use Kohl's ( KSS ) as an example. 

In the second quarter of the company'sfiscal year 2013 (which ended July 30, 2012) inventories as a percentage of sales started to spike higher. (It's wise to compare each quarter with the comparable quarter from a year earlier as inventories rise and fall due to seasonalfactors as well.) Investors would have been wise to sellshares at that point.

By the next quarter, theinventory bulge grew to more alarming levels, and shares fell sharply. Shares are rebounding because management is bringing the inventoryissue back under control.

Kohl's Bloated Inventories

For other firms, keep a close eye ondeferred revenue . If this figure dips from one quarter to the next, it's a sign that orders are slowing, and the company is eating intobacklog to meet sales forecasts. That can only be sustained for a fewquarters before a company -- and theanalysts that follow them -- focus on downward forecast revisions.

3. Watch The Peers
Many investors mistakenly focus on the management commentary of the stock they own when they should also be monitoring what rivals say. When I look for potential sales candidates, I research the company's peers to spot warnings signs, such as falling profit forecasts or a recent steady drop in the stock. More often than not, troubling operating trends that befall one company eventually extend to the whole industry.

4. Look At TheMultiples
In a similar vein, I grow concerned when a stock becomes more richly valued than its peers. Any investors that are new to that industry are likely to pourmoney into the cheaper rivals, whichwill probably cap further appreciation for yourinvestment . 

Don't just look at profit multiples. Other metrics such as the price-to-sales and price-to-book ratios andEBITDA (earnings beforetaxes , interest,depreciation andamortization ) as amultiple ofenterprise value should all be part of your analysis.

5. Track TheInsiders
It's a long-standing investment maxim thatinsider buying is alot more meaningful than insider selling. After all, insiders have plenty of good reasons to sell a stock that may have nothing to do with a company's performance. Yet when a cluster of insiders seek tocash out a huge chunk of their holdings at the same time, it's a clearred flag. 

For example, we recently saw hundreds of millions of dollars in stock sold by insiders at KAR Auction Services ( KAR ) and U.S. Silica Holdings ( SLCA ) in tandem with a secondary stockoffering . If these insiders no longer want to own company stock, why should you?

Risks to Consider: As more of an investmentfactor than risk itself, investors may need to time their stock sales in order to avoid an especially large tax bite in any given year. It may be smart to pair thesale of appreciated stock with that of an underperforming stock. 

Action to Take --> Make no mistake: Some stocks that you sell will keep rising after the fact. That can't be helped. As long as you reinvest proceeds from stock sales into other (presumably lower-priced) stocks, then you are still fully exposed to further marketupside . Then again, sitting on cash is often a wise move, helping you to preserve hard-fought gains after a four-year market surge. 



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


This article appears in: Investing , Basics

Referenced Stocks: KAR , KSS , SLCA

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