Stock Market Timing: How to Know When to Sell

In a market like this, I think it’s safe to say we all have a lot of questions.

That’s why we touch on many different subjects in the Prosperity Dispatch. Recently we’ve focused on when this rally will end, which sectors offer the best long-term opportunities, and the different strategies we can use to take advantage of this market safely.

Questions are good. Asking ourselves questions help keep us on our toes. They help us find new opportunities in different sectors. Heck, finding answers to questions which have led me many winning investments in the past.

That’s why our goal is to try to uncover answers to as many questions as possible. Then we can apply those answers to our own strategies to become more successful investors.

Over the years I’ve been asked a lot of questions. Some have been very thought-provoking. Some have helped lead me to new investment ideas. Some have helped avoid stocks and sectors poised for a fall.

But there has always been one thing that concerned me a bit; most questions are focused on what to buy. Very few questions focused on when to sell.

Most investors spend most of their time figuring out what to buy and when. Then they buy. Which is important, but it always seems like figuring out when to sell appears to be an afterthought.

In a bull market you can get away with that (and a lot of other mistakes). In a market like this, you can’t. That’s why I always pay close attention to warning signs which could be sending a “sell” signal when the masses are buying in.

Giving Stocks a Failing Grade

Three months ago you’d be hard pressed to find a hotter sector than for-profit education. Shares of education companies like ITT Education (NYSE:ESI), Strayer Education (NASDAQ:STRA), and Apollo Group (NASDAQ:APOL) were posting gains in the worst market in decades. Expectations were high and a lot of new money kept pushing up for-profit education stocks.

The prevailing thesis was simple. We’re in a long recession. The U.S. economy is shedding 500,000 jobs a month. Unemployment is going to double digits. Throngs of newly unemployed folks will take the “opportunity in disguise” to retrain and make themselves more marketable. On top of all that, President Obama was just elected and he promised a lot of funding for advanced education.

It was looking like everything was falling into place for-profit educators. And the big money on Wall Street got on board and bid up education stocks to new highs.

We looked into the sector to see an opportunity existed. We focused on the Apollo Group (owner of University of Phoenix), the sector leader. In Companies Thriving in the Great Disruption, we highlighted Apollo as an example of a company putting its cash flows to good use.

From a fundamental perspective, the company was making all the right moves. Apollo was aggressively going after market share in a rapidly growing market (which is usually a very good sign for growth-oriented companies). It offered more promotions to increase enrollment. The company increased its “Other Selling and Promotional Expenses” by 68.9%.It hired more staff. Demand for Apollo’s services was growing and the company was going after more market share.

Investors were rewarding Apollo’s business decisions too. Apollo’s share price nearly doubled between their November lows and post-earnings announcement highs in January. Despite all the good news though, there was something wrong.

No Buyers Left

Apollo was shaping up to be the classic example of good company and poor stock. All the signs were there. We noted that despite all the good news:

[Apollo shares] are actually looking like a great “short” candidate right now. Apollo’s coming off great earnings, the whole education sector is setting new highs, and analysts have been crowding in with “buy” recommendations and raising their estimates.

In the past few months, analysts have been upgrading this stock left and right. Since June, First Analysis, JP Morgan, UBS, and Bank of America, have all slapped their “buy” seals of approval on Apollo. The average estimate for Apollo’s earnings next year jumped from $4.10 to $4.56 in a matter of weeks. Rah, rah, rah…the cheerleaders are out in force.

Here’s my question: Is there’s anybody left to buy? (Note even the insiders – they sold $26 million+ worth of shares last week).

So far the company has [beat expectations consistently], but it won’t last. Great expectations usually lead to great disappointments. And this is shaping up to be a horrific crash if Apollo doesn’t beat earnings by enough next quarter.

It’s shaping up to be a horrific downfall (yet equally profitable if positioned correctly) over the next few quarters.

Although “horrific” was probably a bit too strong of a word, Apollo’s shares performed as expected – dismally. If you take a look at the chart below, it’s not hard to see how a few leading for-profit education stocks fared during this rally (Apollo – Blue, Strayer – Red, S&P 500 – Green):

Any recovery in Apollo’s shares was halted quickly when it reported its most recent quarterly results. The results were good and they actually topped Wall Street’s published expectations, but they weren’t good enough.

And that’s why we looked at Apollo and the education sector as a “sell.” All the warning signs were there and they forecast a downturn was looming for the sector. More importantly, it teaches us about half of the equation of investing successfully – knowing when to sell.

Lessons Learned in Education Stocks

Now, I’m not about to sit here and tell you knowing when to sell is always so obvious. It’s not. But most of the time there are usually plenty of red flags warning observant investors.

In the case of education stocks we had a lot of them. Insiders were selling. Analysts were extremely bullish. The companies were doing well from a fundamental perspective and future expectations were growing with each positive earnings report. Also, the overall markets were rallying while education sector stocks were going nowhere.

The short-lived boom and bust in education stocks shows us why it’s so important it is to pay close attention to warning signs. That way we’ll be able to get out while the getting is good.

Remember, half of the investing successfully equation involves buying the right investments at the right time. The other half is getting out at a good time.

That’s why I consider the best time to decide when to get out of an investment is before you get in. It’s all part of developing a plan before putting valuable capital to work. Whether it’s trailing stops, regular stops, or just a plan of action depending on the risk/reward characteristics, it’s imperative to have a plan before going in. A plan will help reduce the emotions which impact sell decisions and will go a long way to making you a more successful investor.

By Andrew Mickey

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