All-Time High Stocks: Buy and Hold Stocks Forever?

If you could find the next AAPL, why not buy it systematically and hang on forever? That's what @ChicagoSean explored in a recent post. I agree with the idea of focusing on winning stocks. I agree about adding to positions as they gain. But I don't have the stomach to hang on forever...

The table below is from a 2006 study by Blackstar Funds showing total returns for ten big winning stocks. These are examples of the huge potential for gains when you hook a big winner. Microsoft (MSFT) was up 62,188% at its peak. Cisco Systems (CSCO) nearly gained 100,000% at one point. Catching part of the move on one of these stocks could change your life!

But what about after the peak? Often there is a crash. Sometimes stocks go to zero. See how the same stocks fared after they stopped hitting all-time highs. (Keep in mind the table is from 2006 so the losses have gotten larger for some companies.)

Hanging on to a former all-star like General Motors untill the bitter end was a bad idea. Forget about the 3000% run-up because it went to zero. That is why I think it is important to figure out a way to exit after the stock has peaked.

But when is the right time to sell?

I'll start with the premise that huge long-term gains are fueled by growth. Growth of companies with dominant positions in growing industries and with compelling growth "stories". Share prices reward these things. But eventually companies lose dominance, the story gets tarnished, and the share price slides. The ideal time to sell is when growth has stalled and dominance is fading.

Unfortunately it is difficult to see that an empire is ending. All I can offer are some ideas on when to get out:

The business starts deteriorating -- I watch the Piotroski F-score and Altman Z-score, which are indicators of business strength (available for most US companies on grahaminvestor.com).
Dividend cut -- If the company runs low on cash then something isn't right. Unfortunately this warning sign comes after much damage has already happened.
Underperforming against an index -- If the stock underperforms within its own sector that could be a sign of deterioration. The challenge is choosing a meaningful timeframe.
Trailing stop -- Placed a distance below the all-time high: wide enough to allow for normal cyclical swings yet high enough to retain profits if the stock plummets. The simplest approach would be to exit if the price falls a fixed percentage below the high. A more complex option is the Average True Range (ATR), which is based on volatility and is what I use.

Examples of a loose trailing stop for long-term trend-following:

American International Group (AIG) - This was a terrible outcome for the patient buy-and-hold approach. After holding this stock for a quarter century the buy-and-holder is left with a big loss and a good pub story. Using a 20-ATR trailing stop, shown as a red line, protected most of the gains.

American International Group (AIG) stock boom and bust - AIG stock chart, trendfollowing with 20-ATR trailing stop

McDonalds (MCD) - The 20-ATR tailing stop gives a sell signal in 2002 but if the trailing stop was used as a buy signal then you were back into MCD in 2003. Most of the gains since 1981 were captured.

McDonalds Corp. MCD stock chart, long-term trendfollowing with 20-ATR trailing stop

Apple Inc. (AAPL) - Some whipsawing in '08-'09 but the trailing stop has captured most of the gains.

Apple Inc. AAPL stock chart, long-term AAPL chart trendfollowing with 20-ATR trailing stop

At the end of the day APPL is not AIG or GM. Maybe AAPL's share price will keep rising for the next 25 years. Maybe 50 years. I have no idea. I don't mind volatility but I am not prepared to close my eyes and blindly ride a stock wherever it takes me because I might ride it into the ground.

An exit plan must be identified for every investment before the investment is made. This plan should cover all possible outcomes of the trade, both profit and loss. - Braden Glett

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