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Why you should set a ‘sell’ price before you buy a security

As an investing reporter, I get plenty of correspondence from Globe and Mail readers. One such reader recently wrote in asking about Empire Co. Ltd., asking, "It seems that they stumbled over the acquisition of Safeway. I am now down 27 per cent but I am reluctant to sell and lock in that loss. Is it worthwhile to hold on to this investment and hope for a recovery some day? Or would the remaining funds be better invested in another venture?"

I am very sorry to hear about this reader's situation. I know how hard it is to save money and how stressful it must be to watch these savings decline. This is a key reason that having a diversified portfolio is so important.

Portfolio management is not just about buying, it is also important to develop a sell strategy. Ideally, you want to avoid owning "torpedo stocks" – those that keep plunging in value. For that reason, I always stress setting a sell price before purchasing a security – a price you sell at if a company's fundamentals deteriorate. This can help to avoid holding a "graveyard" of underperforming securities.

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If you learn about a company experiencing headwinds or operational issues, consider selling.

Successful execution of turnaround strategies takes time, so don't expect management to have a quick single quarter fix. Furthermore, earnings disappointments typically translates into negative revisions by analysts, which creates sellers and drives a stock price lower.

That being said, what does an investor do if he is left holding shares of a torpedo stock such as Empire? To help you make an informed investment decision, let's briefly review its main attributes.

The company

Nova Scotia-based Empire is Canada's second-largest food retailer with a national presence through its core banners Sobeys, IGA and Safeway.

Here are some factors that are putting Empire stock price under pressure:

Weak earnings reports. For the past three quarters, the share price has fallen markedly after the company reported disappointing quarterly financial results.

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Negative earnings revisions. Earnings estimates have been drifting down significantly since the beginning of the year. For instance, on Jan. 1 the consensus earnings-per-share estimate was $1.92 for fiscal 2017, and has since fallen to $1.15.

Deteriorating financials. Last quarter, same-store sales excluding fuel declined 1.2 per cent year-over-year and profit margins declined. The integration of Canada Safeway, as well as economic weakness in Alberta and Saskatchewan have been challenges.

Intensifying competitive pressures. There is a lack of food inflation, and disinflation on some categories. Aggressive promotional activity is intensifying, squeezing profit margins for grocers. Empire lacks a national discount store presence, which would help the company fend off competition.

Declining market share. Management stated on the recent earnings call that, "We still see erosion of our market share in the Eastern part of our business."

Management in transition. In July, the company announced the departure of Marc Poulin, the former president and chief executive officer. François Vimard is acting as the interim CEO while the company searches for a replacement.

Dividend policy

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In June, the company announced a hike to its quarterly dividend of about 2.5 per cent to 10.25 cents a share. This equates to an annualized dividend yield of 2.2 per cent.

Valuation

Valuations for food retailers are contracting – multiples are coming down – which could put further pressure on Empire's share price. Analysts typically value the stock using a sum-of-the-parts analysis. Analysts' target prices range from a low of $18 to a high of $23, with the average one-year target price at $20.38.

Analysts' recommendations

According to Bloomberg, there are nine "hold" recommendations, two "sell" recommendations, and just one "buy" recommendation.

Insider transaction activity

Despite the sell-off in the share price, insiders have not been acquiring a meaningful number of shares.

Chart watch

Year-to-date, this is the worst performing stock in the S&P/TSX composite index consumer staples sector.

There is initial overhead resistance at $20, close to its 50-day moving average, and after that around $22, near its 200-day moving average.

In terms of downside support, there is initial support around $19, with the next major support level between $17 and $18.

The bottom line

My general rule of thumb is not to invest in a turnaround company until there is evidence that a recovery is in place.

In this particular case, I do not know this reader's investment circumstances so I cannot determine whether he should hold or sell this stock. However, what I can say is that patience is likely required for the share price to materially appreciate as operational issues need to be resolved, industry challenges persist, valuations are contracting in the sector, and investor confidence needs to be restored.

As always, I strongly encourage readers to consult a financial adviser, and to do their own proper due diligence before taking any investment action.

The author does not personally own shares in the security mentioned in this story.

Jennifer Dowty, CFA, Globe Investor's in-house equities analyst, writes exclusively for our subscribers at Inside the Market.

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About the Author
Equities analyst

Jennifer Dowty, CFA, is an equities analyst at The Globe and Mail. She has approximately 18 years of experience working in the financial industry, 14 of those years were at Manulife Asset Management, where she worked her way up to become an Equities Portfolio Manager. More

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