Taking a Loss

Well, it finally happened. I sold two positions at a loss today, since the company fundamentals no longer met my criteria. These are the first losing positions I've had in over two years of covered call trading, but it was the right thing to do according to my trading plan.

As my knowledge of value investing and how to analyze a company improves, my criteria for "What to Buy" has evolved, thanks in part to F Wall Street. After reading their analysis of Johnson & Johnson, and the accompanying spreadsheet, I began to look more closely at the company balance sheet, cash flow sheet, and key ratios.

I've also thought more about "When to Sell". As stated in my previous article on the subject, I'll only sell a losing position if/when the company fundamentals no longer meet my criteria. That's what happened to the two positions I sold for a loss today. After writing that article, I went back to re-analyze all of my current positions using my new spreadsheet, which is modeled after the one from F Wall Street.

The following explains why I sold each of these positions.

AMD

I established this position in Jan07 since it met my criteria at that time. When I looked at AMD now, using my new fundamental analysis spreadsheet, I was surprised to see that it didn't meet any of my fundamental criteria. So, obviously either my previous criteria wasn't robust enough or I was asleep at the wheel when I established this position.

If you look at the spreadsheet for AMD, you'll see that the company has negative free cash flow, and negative returns. Now, compare that with the spreadsheet for INTC, which is their major competitor. It's like night and day. Clearly, INTC has a competitive advantage over AMD and is much more profitable, generating a lot of free cash flow and double digit returns. It's pretty much a no-brainer when you compare these spreadsheets.

So, obviously I made a mistake in establishing this position, therefore the decision to sell, even at a loss, is the right thing to do.

PALM

I established this position Apr06, again because it met my criteria at that time. The fundamentals aren't as bad as AMD, however, they aren't that good either. But the main reason for selling this position is that PALM is losing it's competitive advantage to its competitors, like MOT.

Again, comparing the spreadsheets on PALM and MOT you can see that PALM is not doing as well as MOT. They've lost market share, which is affecting their profitability and the prospects going forward don't look too good.

So again, the decision to sell, even at a loss, is the right thing to do.

Conclusion

Now, I could have held these positions, and eventually exited at a profit, for the sake of keeping my winning streak intact, but that would have been an emotional response. But this is not about emotions or my ego, it's about making the right decision according to my trading plan. No emotion, no regret, just follow the plan.

You can be sure that going forward I'll be more careful in my analysis of company fundamentals, so, hopefully, mistakes like this should be rare. Everyone makes mistakes, but it's how you deal with them that matters. It's better to admit a mistake and learn from it then to bury your head in the sand and deny it. The most important thing to remember is to make sure you gain from the experience. No one wants to learn the hard way, but you learn more from your mistakes than from watching or reading about others. Mistakes are an inevitable part of life, so you better learn the right way to deal with them. This will not only make you a better person, it will also make you a better investor.