Why you should let your stock winners run and dump your losers ASAP

There's a wide disparity among stocks in the S&P 500 Index.

  • By Jeff Reeves,
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Many investors have heard the old saw that “it’s not a stock market, but a market of stocks.” The saying is meant to imply that while we talk a lot about the general direction of a bull or bear market, it’s just as important to acknowledge the qualities of individual stocks.

It’s a mindset that’s worth remembering in 2018, when the S&P 500 Index (.SPX) is sitting on a middling return of about 4% since Jan. 1, but there have been plenty of fireworks when you look at individual stocks across more focused time periods.

Take blue-chip General Electric (GE), which has crashed and burned about 50% this year after yet another dividend cut, and compare it with perennial high-flier Netflix (NFLX), which is up more than 70% in the same period, thanks in part to big earnings in October.

This trend isn’t just a recent occurrence. Recent data shared by Longboard Asset Management show that if you back out the top 20% of all stocks since 1989, investors would be sitting on a net return of zero.

Looking at the top five and bottom five stocks in the S&P 500 across different time frames — the top 1% and the bottom 1% — it becomes clear that one big winner can make you a fortune, and just one mistake can leave you in the poorhouse.

Best and worst in the past 30 days

October was a volatile month on Wall Street. But all told, the S&P 500 is down just about 3% in the past 30 days. So why all the fuss? Well, because some stocks had it much worse than others, thanks to specific struggles with their business, like the aforementioned General Electric and its dividend cut. And at the same time, specific news caused a select group of stocks to rocket higher, including IBM (IBM) paying some $34 billion to acquire Red Hat (RHT).

The five best S&P 500 stocks in the past 30 days include:

  • Red Hat Inc., up 41%
  • TripAdvisor Inc. (TRIP), up 22%
  • L Brands Inc. (LB), up 21%
  • Twitter Inc. (TWTR), up 20%
  • Starbucks Corp. (SBUX), up 18%

The five worst S&P 500 stocks in the past 30 days include:

  • Frontier Communications Corp. (FTR), down 42%
  • General Electric Co., down 32%
  • Diamond Offshore Drilling Inc. (DO), down 30%
  • Align Technology Inc. (ALGN), down 28%
  • Nektar Therapeutics (NKTR), down 27%

Average 30-day returns:

  • Five best: up 25%
  • Five worst: down 32%
  • S&P 500: down 3%

Best and worst in the past 12 months

Further back in time, the winners look even more dramatic, including accessory company Fossil (FOSL), which has seen its shares roughly triple in the past year, thanks in part to a massive short squeeze in February. But it’s important to note that a short-term surge of roughly 70% in early 2018 was only one piece of the puzzle, and investors who have let this winner run have been well-served.

Similarly, the recent big move downward in GE on a dividend cut is only part of the narrative. This is a stock that has been challenged for a long time.

5 best S&P 500 stocks in the past 12 months

  • Fossil Group Inc., up 201%
  • Advanced Auto Parts Inc. (AAP), up 115%
  • Macy’s Inc. (M), up 112%
  • Abiomed Inc. (ABMD), up 109%
  • Kohl’s Corp. (KSS), up 99%

5 worst S&P 500 stocks in the past 12 months

  • General Electric Co., down 55%
  • Mohawk Industries Inc. (MHK), down 52%
  • Frontier Communications Corp., down 50%
  • EQT Corp. (EQT), down 46%
  • Western Digital Corp. (WDC), down 44%

Average 12-month returns:

  • Five best: up 127%
  • Five worst: down 49%
  • S&P 500: up 8%

What’s the trade?

If past is precedent, then investors should take notice of these trends and put their emphasis on picks with near-term momentum that is significantly higher, while dumping big losers ASAP before they get even worse.

Of course, the devil is in the details. Because it’s worth noting that before Fossil’s massive run in 2018, it was one of the worst-performing stocks on Wall Street with minus 70% returns in calendar 2017, owing to weak profits. A dramatic turnaround in sentiment resulted in a dramatic turnaround for this stock.

Similarly, one of 2017’s biggest winners was casino operator Wynn Resorts (WYNN). The stock soared roughly 90% in 2017 but has flopped more than 35% in the past 12 months after a series of poor earnings reports and fears that its China business is in trouble.

It’s important to keep these examples in mind, because no winner will run perpetually higher and there are indeed examples of stocks that come roaring back from the depths. But the basic notion remains that momentum matters, and it’s crucial to pay attention to this fact instead of getting sentimental.

Selling a winner quickly for fear the profits will evaporate can leave a lot of money on the table, and hanging on to a battered stock because you’re hoping for a turnaround often leaves you in even worse shape.

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