INVESTING: Know when to let go of a once-hot stock

Raise your hand if you ever get emotional about a stock. You lost money on it once, or the company has a bad reputation and you refuse to buy it. (As I mentioned last week, that almost kept me out of GM. I’m glad I let the facts make the decision for me. GM is up four bucks a share in the last few weeks.) Or, even worse, you hold a stock for a while, then, a few years later, you look up and realize you really overstayed your welcome.

I think a lot of retail investors are doing that with Starbucks today. The stock had a terrific run throughout the 1990s and didn’t get banged up that bad in the bear market. Since late 2001, Starbucks has really turned it on, going from $7 a share to almost $40. But that kind of action can breed complacency. People tell themselves that when the stock falls (as it has recently) that it’s always come back before. And while it almost surely will come back again this time, it is a question of how much and how far.

Cannibalism bites, and I think that is going to be the longer-term problem for Starbucks. The five or six in my hometown are at least a few miles apart. But near my office downtown, it is a different matter. There are two within a one-minute walk of each other, and there is a licensed reseller right smack in the middle of those two. I know people drink a lot of coffee, but there is a limit to everything. The near-term risk in Starbucks is at least $5 a share, and the longer-term picture might be one of underperformance. These days, there are easier ways to make a buck.

During the early part of this decade, investors held on to Wal-Mart believing it would return to its glory. Recently, these people have been waking up and selling the stock into rallies. On average, the stock price has performed worse than its average price during the bear market. Not too many companies can claim that distinction. But Wal-Mart was one of the greatest wealth generators investors had seen. Some people have been in it for the better part of that ride, and have suffered years of underperformance since. Even today, Wal-Mart is not in any danger of going on a multi-point tear. Cut the emotional strings and move on.

Apple and Google have been faster-paced on the way up, but the emotional ties are no less compelling. Leaders of these two companies have grown into cult heroes. When they release earnings, it’s almost as if they have printing presses in their basements.

But it won’t go on forever. At some point, both stocks will fully reflect their long-term potential, and it is at that point that the faithful should trade up for bigger and better things. Let me stress that it still should be months from now before major selling sets in. I think Apple can hit more than $110 a share by the end of this year, and Google should see north of $600. From current levels, both moves represent a slight outperformance of my general market expectations for 2007. But as I said, at some point it will end.

The recent GM move re-enforced a valuable lesson for me. Doing well in the market is both art and science. But emotions don’t belong.