July 08, 2004, 8:58 a.m.
The Bear Market Needles
When you get a winner, hold onto it.

In September 2002, in a piece entitled “The Clinker Index II,” I wrote about the big losers in the bear market of 2000-02. I pointed out that a list of well known institutional quality stocks had declined, on average, 99.3 percent. I concluded from this research that “investors should monitor the changing price and the fundamentals of individual stocks that they own. They should also be willing to sell stocks — even if there is a tax liability — rather than holding on and hoping that they will come back.” (Novice investors can calculate how much — as a percent — these stocks as a group would have to rally to get back to break-even.)

Okay, let’s stop being so negative. Even though stocks as a group declined a record amount during the bear market, there were many individual stocks that were big winners — a fact that points to the difference between markets and stocks. Two keys to success in any market environment are finding the needle in the haystack and then keeping that needle — i.e., hold onto your winners.

The problem that many money managers face is that they find the needles but they don’t hang on. Let’s say a mutual fund manager hits upon a really good stock and acquires a 2 percent to 3 percent position in that stock. If the stock doubles or triples, it can become too big a portion of a portfolio and at some point, whether it be at a 5 percent or 10 percent position, the mutual fund manager begins to sell the stock and look for another needle. In my opinion, by selling these big winners early, the chances of outperforming the market diminish.

As a day-to-day portfolio manager, I come across a few needles. Recently, I noticed that there have been a few big winners among a few of the stocks that I have been interested in. (If it were more than a few, I wouldn’t be writing this piece.) Below is a table of ten of those stocks, with related information that’s important for stock-picking. These stocks were all among the best performers during the last bear market. The rates of return are spectacular, but few if any mutual fund managers could have fully participated in these gains. Why? They would have had to keep positions within specific boundaries relative to other holdings.

This table also includes comparative data of a few large-capitalization companies — all well known to the institutional investment community as evidenced by the number of mutual funds that hold these stocks. One might ask, Who would be interested in buying these large-caps when they are held so broadly in the institutional marketplace? On the other hand, most of the really big winners on this list still have low institutional sponsorship. Also, when company management holds a big stock position in a company, the decision makers are more likely to have the incentive to do well for the shareholders.

One more point: When comparing the 2,610 percent average return of these stocks during the bear market to the 40 percent gain of the bluest of blue chips one can see that the selection and holding of good ideas can be especially rewarding even when the overall market has turned down.

P.S. The answer to break-even? 14,286 percent!

— Thomas E. Nugent is executive vice president and chief investment officer of PlanMember Advisors, Inc. and chief investment officer for Victoria Capital Management, Inc. As an investment advisor and an investor, he has held or does hold individual positions in the following securities that are mentioned above: AVD, BLUD, COH, NUTR, SHFL, SOHU, SNIC, USNA, and URBN. This article should not be misconstrued as any type of recommendation to buy or sell any of these securities.