Expert: Paul Henneman - 5/8/2006

Question
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Followup To
Question -
Hello Paul

Today my entire year-to-date gain in the stock market was wiped out due to bad earnings reports in two of my stocks.  I would like your opinion on a strategy to guard against this.  The only thing I can think of at the moment is not holding companies that have an upcoming earnings reports (I do make fairly frequent trades).

Any thoughts would be welcome.

Thanks.
Answer -
Peter,
   Thank you for your question! My first suggestion would be to hold more positions. I strongly believe that even small scale individual investors should hold at least 10 stocks, 15 or 20 is better. With more holdings, the impact of such things would be greatly reduced.
   It also depends what type of stocks you typically hold. Were those small cap stocks? It is true that smaller cap stocks can offer stronger returns, but they are much more volatile and see those types of fluctations much more frequently that large cap stocks. Perhaps a larger portfolio that has small cap, mid cap, as well as large cap stocks would allow you to be better diversified.
   A final component would be to make sure you are holding stocks from various industries. Often entire industries fall on hard times as general trends can affect all companies that do similar things. If you have the majority of holdings in your portfolio from the same industry, you could be hit hard all at once.
   I hope this helps somewhat. It is of course more difficult to manage a larger portfolio and ensure that you are diversified in terms of market cap, number of stocks, and industry. But will worth it if you want to have a less bumpy ride! If you would like to discuss this further and would be willing to share information regarding how many total stocks you hold at one time, and the amount of diversity you have among these stocks in terms of market cap and industry, I would welcome any follow up.

Sincerely,
Paul Henneman
President
ValuEngine, Inc.
www.ValuEngine.com
www.VEInstitutional.com
www.VEReports.com
www.ValuEngineView.com

Hi Paul

Those sound like good suggestions.  As a rule I hold at least ten stocks at a time, and never anything under $20.  Since those two losses happened overnight right after periodic earnings reports, and fell right through my stops, I was thinking that next time the day before an earnings report comes out I will buy puts at a strike price just below my stops.  The day after I will sell the puts (along with the stock if there happens to be a big loss).  It seems equivalent to a short term insurance policy.  What do you think?

Pete DeCamp


Answer
Thank you Pete for the follow up!
I generally don't believe in loss stops. I say this due to years of research that we have done. For example, when poor earnings reports come out, there is generally a knee jerk reaction that over compensates, and by the time you get the trade in, it is too late. The stock may recover somewhat shortly thereafter.
I do believe strongly in adjusting a portfolio through intense research on a periodic research. I have found that adjusting a portfolio once a month works well. I hold all stocks for a full month, no matter what, then research at the end of the month. It is difficult, but the key is to stay completely objective. The only question is if the funds can better be used in other ways, and not to worry about if losses will rebound or if you should take profits.
This general idea can be applied to the two stocks that really hurt you recently: the simple question is if those companies are still attractive or not. Can the funds be better used in other areas? Or is the company still solid and it is best to ignore the drop?
I have to admit that our company is a quantitative firm. We run computer models, find the stocks according to the computer that fit our profile, and hold them for a month. Works great, there are bad months, but overall performance is excellent. And I sleep well at night!
There are some good books out there regarding quantitative approaches is interested. Two I suggest are 'Market Neutral Investing' by Eric Stokes, and anything by William O'Neil.

I hope this helps, please feel free to continue to follow up if I can be of any  further service,

Sincerely,
Paul Henneman
ValuEngine, Inc.
www.ValuEngine.com
www.VEInstitutional.com
www.ValuEngineView.com
www.VEReports.com