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Guru Investor / John Reese7/15/2008 12:01 AM ET

Know when to fold 'em

I'm selling 12 of my 20 stocks, including several that have cost me big, for others with more potential right now. A systematic approach makes it easier to take a loss and move on.

Strategy Lab is MSN Money's stock-picking challenge. To learn more about the game and the contenders, click here.

It's last call.

With only two weeks left in this round of Strategy Lab, today's regular monthly rebalancing of my portfolio will be my last during this contest. It comes after a particularly rough stretch, both for me and for the overall market. Just as the major indexes have taken some hits in the past month, so too has my portfolio -- and now my Guru Strategy computer models are telling me it's time for a major shakeup as we close in on the finish line.

I'll turning over more than half of my 20-stock portfolio, replacing 12 of my holdings with stocks that score better on my models. Among the departing are a number of big losers, with Men's Wearhouse (MW, news, msgs), Lloyds TSB Group (LYG, news, msgs), Parker Hannifin (PH, news, msgs) and Bank of Ireland (IRE, news, msgs) all down about 20% or more since I purchased them. Both the general market downturn and the fear-driven beating financials have taken recently played a big part in those declines.

As for the newcomers, I'm heading back to the well on half of them. Six of the stocks I'm adding -- Abercrombie & Fitch (ANF, news, msgs), Best Buy (BBY, news, msgs), General Dynamics (GD, news, msgs), Greenhill (GHL, news, msgs), ING Group (ING, news, msgs), Jos. A. Bank Clothiers (JOSB, news, msgs) -- appeared in my Strategy Lab portfolio earlier in this round. Several of those plays, including Best Buy, General Dynamics, Greenhill, ING and Jos. A. Bank, netted me solid gains, and now I'm hoping they'll do so again. While their fundamentals remain strong, their prices have all dropped recently, making for some excellent buying opportunities.

With this rebalancing, the breakdown of stocks in my portfolio, by guru, is:

  • Warren Buffett-based strategy: Thor Industries (THO, news, msgs), Abercrombie & Fitch, Best Buy and Walgreen (WAG, news, msgs).

The big rollover

One thing that I think is key to note about my trades this month is that, for someone who stresses staying the course and having a long-term approach, I'm certainly letting go of a lot of stocks that have taken some big hits in recent weeks.

If these really were strong companies to begin with, don't I expect them to bounce back?

In many cases, the answer is yes. In fact, several of the stocks I'm selling still get high marks from my guru-based computer models, and I believe many of them will bounce back strong over the long haul. But right now, my models are now finding other stocks with more upside potential in the market. So while several of the stocks I'm dropping have good bounce-back potential, the stocks I'm adding are even more likely to take off, according to my models.

This relates to something I've touched on before. A good investor must learn from his mistakes -- even the best will make them -- but he or she can't dwell on them. Yesterday's losses are done and over with. Nothing you do today, tomorrow or next week can get them back.

Looking for new gains

What you can do, however, is make new gains. And doing that requires that you periodically reassess your portfolio in as objective a manner as possible, filling your portfolio with the stocks that you believe have the best potential at any given time. Sometimes, that means letting go of a weakening stock even though you hope it will rebound and spare you a loss. Other times, as my rebalancing this month shows, it means letting go of good values to scoop up even better ones.

That need for an objective portfolio reassessment is a big reason why I use a purely quantitative approach. By relying strictly on the numbers -- a stock's fundamentals -- I don't fall prey to emotional urges, including the urge to hold on to a stock because I don't want to deal with the ego blow that comes with taking a big loss.

Wherever the best values are according to the numbers is where my portfolio will go. And as we head toward the finish line here, I'm hopeful that approach, and these new top-rated Guru Strategy picks, will put the wind at my back.

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John ReeseGuru Investor John Reese

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