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Subject: Build a Better Portfolio in 10 Days: Day 4

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Doug Gerlach
Cambridge, MA
http://www.iclub.com/
President, ICLUBcentral

02/23/2007 5:19 PM
So how did you do in looking at your portfolio diversification? Hopefully you have an idea of where you should be considering some changes in your portfolio. Now we're going to start looking at individual stocks that you own. (Investor's Toolkit or another software analysis program will help you out with these tasks.) So let's go ahead and: 4. Identify overpriced stocks in your portfolio. These are stocks that may have performed very well for you in the past -- so well, in fact, that they are now overvalued and will likely generate very little return for you in the near future. And because these stocks are at the high end of their historical valuation range, there's really only one direction they can head towards in the short-term -- and that's down. What makes a stock overvalued? There are three points to look at: 1. Is the Relative Value greater than 150%? RV is calculated by dividing the Current PE Ratio by the 5-year Historical Average PE Ratio. If the RV is at 150%, then the Current PE is 50% more than it has been on average. In other words, other investors are likely to be way too excited about the stock for their own good. 2. Is the Upside/Downside Ratio less than 1:1? The U/D Ratio compares the potential upside in five years from the current price to the potential downside. For new purchases, you want an U/D Ratio of 3:1 or greater. If the U/D Ratio is approaching 1:1, then you have an equal amount of upside compared to the downside risk, and that's not enough upside to offset the risk of holding the stock. These stocks may also be in the Sell zone in Investor's Toolkit. 3. Is the projected Total Return over the next five years too low for your objectives? Or can you get a better rate of return by investing in long-term bonds? There's no reason to continue to hold a "risky" investment (like a stock) if you can earn the same return on "safe" government bonds. Investor's Toolkit 5 introduced a new way of thinking about managing your portfolio when it comes to over-valued stocks with the Offense Report and Offense Alerts. On the Offense Alerts screen, you will see stocks in your portfolio flagged if the U/D Ratio is less than 1:1, or if the Total Return is lower than your threshold (which is 15% by default). These values will appear in red text. The Relative Value is also displayed. The irony of considering these over-valued stocks to be "problems" is that they may have been your big winners, and it can be tough to let go. And if you've been taught that it's best to let your winners ride, that's true, too. It's just that there can sometimes be too much of a good thing, particularly if the stock has grown so much that it's tipping your portfolio out of balance. So, how does your portfolio look? Generally, dealing with overvalued stocks is not as urgent as getting rid of problem companies, so we're going to move on to look at some more serious portfolio concerns before dealing with these overpriced stocks. It can be useful, though, to make a note that these stocks are AFC -- Available for Cash. If an appealing opportunity comes along, selling an overvalued stock in order to redeploy the funds into a stock with a higher possible return doesn't require much thought at all! Doug

Posting from ICLUBcentral world headquarters in the Harvard Square's historic College House, Cambridge, MA

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