Is Your Buy-and-Hold Stock Now a Sell?

Let's say five years ago you bought shares of Cisco(CSCO Quote - Cramer on CSCO - Stock Picks) at a split-adjusted price of $5.15 a share. And you stuffed them away in part of your portfolio marked "buy and hold." These were going to pay for your retirement, the kids' education, a time share at the beach. Whatever.

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Is Your Buy-and-Hold Stock Now a Sell?

For the four years following your buy, the only reason to check the shares was to count up your paper profits. By March 27, 2000, a $10,000 investment in Cisco was worth $156,220. No doubt about it, spectacular gains in just more than four years.

But we all know what happened in March 2000. The technology-heavy Nasdaq Composite Index peaked and then began the long descent that's still going on. Cisco, after peaking at $82, fell to $61 in August and then $36 in December, and finally, hit $18 and change this month. Instead of being worth $156,220, that $10,000 investment of March 1996 is worth around $36,707.

Intel(INTC Quote - Cramer on INTC - Stock Picks). Microsoft(MSFT Quote - Cramer on MSFT - Stock Picks). No matter what technology buy-and-hold stock you look at, the numbers change but the story remains the same: Huge run-ups in the bull market rally of the 1990s and painful losses in the past year that wiped out a good part of those gains. All across America right now, buy-and-hold investors are questioning their basic commitment to this brand of long-term investing and wishing that they'd sold quarters or months or even weeks ago.

And they're wondering what to do now with those shares of Cisco, Intel, Microsoft or any of the other big-name buy-and-hold technology stocks. (Editor's Note: Microsoft is the parent of MSN MoneyCentral.)

So how do you decide whether a battered buy-and-hold stock is now a sell or still a keeper?

First, Confront Fear and Embarrassment

What makes that potential sell decision so hard to make? Chagrin at having ridden a stock down from its high to the current price. No one who owned Intel at its 52-week high of $75.81 is really happy that they've ridden it down to $29 and change. Fear is another disincentive -- fear that the stock will start to go up just when we sell. Riding it down was bad enough, but selling at the bottom would be even worse, we feel. These are some of the emotions that I feel when I look at the buy-and-hold stocks I still own. You can probably add more emotions from your own experience.

I don't think there's any point in trying to deny we feel these things. In fact, the desire to hide our chagrin or fear is a major barrier keeping us from making sound decisions about these stocks. I think it's much better to admit the emotions and then try to give them a place in the sell-or-hold decision-making process. All buy-and-hold investors feel like this now -- join the club.

I'm going to suggest a process for making this sell-or-hold decision for buy-and-hold stocks in the current market. The five steps begin with a memory exercise, including some traditional valuation calculations, and end with an attempt to put those normal emotions into a context that will help you make a sound decision. After laying out that process in general, I'm going to apply it to Cisco Systems, Intel and Microsoft.

Five Steps to Decide Whether to Sell

Step 1: Memories. Decide if your original reasons for owning this stock for the long term are still convincing. I'm not asking you to do any numbers here but simply to look at the reasons that you bought the stock in 1996 or whenever and see how convincing they seem to you now. This kind of qualitative look at a company and its stock will give you a surprising amount of help when we start to crunch numbers. If, for example, you bought shares because the company dominated its market then, how dominant is the company now? Is the technology lead of a technology leader still as strong, or has the company's edge over rivals decayed significantly? Has the market for the company's products zigged when you expected it to zag, so that customers increasingly prefer new products from competitors instead of the aging bestsellers this company is still pushing?

Step 2: Calculate a reasonable best-case return if you held this stock for the next five years. I'm not hoping for 100% accuracy here, just a sense of what I might be able to expect from a stock at the end of five years if I held on through the current mess. Granted, any projections are subject to big errors in the current confused economy, but since potential return is at the crux of this sell-or-hold decision, I think we have to try. Nothing tricky to the method here; simply take the best estimates of 2001 earnings you can make, heavily discounted for the downturn this year. Then, do the same for 2002, after carefully considering that growth that year could be slow, too. Finally, apply your estimate of long-term growth for the 2003 to 2005 period. Multiply that by a price-to-earnings ratio that looks back to valuation before the recent technology bubble to get a price per share at the end of 2005. Finally, turn the difference between that target and today's price into an annualized rate of return. Is the stock worth holding if that's your potential gain?

Step 3: Feel the pain. You've just figured out how much you could make if you held the stock for five years. Now take a look at how painful it could be in the short term as you wait for the long-term gains to kick in. Use whatever methods you can find to come up with your short-term downside estimate, whether it's technical analysis, historical fundamentals, analyst estimates of fair value or recent trading patterns.

Step 4: Estimate how long a stock might be dead money. Business for the companies in the technology sector isn't going to turn around in lockstep. Some analysts are now saying that the June quarter could mark the bottom for revenue declines at semiconductor makers, and Intel has speculated that it could see the traditional seasonal uptick in business this fall. Cisco and other network- and telecommunications-equipment makers, on the other hand, are now talking about December or later turnarounds in their business. Why do you care when the turn might come? Until companies start to tell investors that they can see business improving, it will be hard for technology stocks to move up in a sustainable way. The longer a stock is dead money, the more reason there is to sell instead of hold, even for a long-term buy-and-hold investor. And the longer this dead-money period lasts, the less chance there is that you'll mistime your decisions to sell and buy back the stock.

Step 5: Put it all together and make a decision. No hard-and-fast rules for how to do this. This is the step where you try to take account of your emotions -- and your own investing skills and psychology.