Thursday, January 10, 2008

Selling a Long-Term Holding

Selling a stock we’ve held for quite a while, and which has done well for us, is always a difficult decision. We are often asked how and why we do that, and it’s always a good question.

Here’s a good example: We just sold WellPoint, Inc. (WLP), one of the largest healthcare insurers in the country, which we had held for the last 13 months. We bought WLP, along with Aetna (AET), to maintain our position in the healthcare insurance segment, shortly after taking our profits in UnitedHealth (UNH). That proved to be a good decision, since both WLP and AET have outperformed UNH, as well as the S&P 500 Index, since we bought them. (See our blog post “Back to Healthcare” dated December 6, 2006.)

So why sell WLP now? The most important reason is that the company no longer meets our investment criteria. Their current stock price is just below an all-time high and it now exceeds what our valuation model tells us the company is worth. Secondly, they are no longer an EVA company, meaning that their return on capital has drifted below their cost of capital while we have held the stock. That’s reason enough when we can book an 18 % long-term gain, even though we think there could be some appreciation in the stock over the next year, based on what the company has recently said in an analysts’ meeting.

However, there was another rather compelling reason for us to sell WLP here. We recently had access to a somewhat obscure, but very well done, piece of research that said that WLP has approximately $300 million in sub-prime, mortgage-backed securities on their books, which they probably will have to substantially write-down, as of the end of 2007. While $300 million is a relatively small portion of their investment portfolio, it is still a lot of money, and the write-down would come at a time when no one wants to hear about another company losing money on sub-prime mortgage investments. If this happens (and we can’t say for sure it will), we think the stock could trade down for a period of time, thereby impairing our gain.

So, this combination of factors (i.e., the company becoming overvalued, as well as not meeting our EVA criteria, plus the desire to protect our 18 % gain in a difficult market) gives us our sell signal. Of course, we can’t know for sure what will happen after we’re gone. But one thing we do know is that we beat the market with this holding and we are quite sure we’re going to have other places to deploy our cash, as the market continues to give up the meager gains it made in 2007.

Note: At the time of this posting, Jack and Peter Falker and the clients of FalkerInvestments Inc. were long Aetna (AET).