THE VALUE INVESTORS

are back! After only one day last week in which the Dow soared as the Nasdaq dropped, the New York Times put value champion Warren Buffett on its front page. Journalists have been falling over themselves to proclaim the death of growth stocks. Can it be?

I remember the first time I visited a financial planner, many years ago, saying I wanted to put some money in mutual funds. "Value or growth?" was her first question. I paused for a moment, then replied that what I had in mind was both. Both? The comment sent her into a tailspin.

The division of the investment world into "growth" and "value" still doesn't make any sense to me. Sometimes I recommend stocks (and buy them for my own account) that seem to be growth stocks, and other times I go for value. Flexibility to me is more important than ideology. The market is too complex and unpredictable to reduce to any single formula.

So my approach is to borrow elements from both camps. Benjamin Graham's seminal work in the 1930s advocated investing in stocks of companies with low prices relative to their underlying values. His argument was that the market tends to overestimate the growth prospects and underestimate the risks of highly touted growth stocks. The stocks he favored typically had low price-to-earnings ratios (though that was hardly his only criteria) and he avoided stocks with high P/E ratios. Growth advocates such as T. Rowe Price, by contrast, argued the opposite: That low P/Es accurately reflect a company's relatively poor prospects and that the market tends to underestimate growth prospects, even when P/Es are high.

But both camps agree on one thing: The market sometimes errs in assigning values to stocks, errors that are corrected over time as events unfold and more information becomes available.

I, too, agree with that fundamental premise; otherwise I'd stop writing this column and put my money in an index fund. But I also believe the market is often right, usually more often than not. There are sound reasons why some stocks have low P/Es and others high. When errors are made, they can as easily be from overpessimism as from overoptimism. In other words, errors in valuation can occur as frequently in value stocks as in growth stocks. Sometimes these mistakes occur across the board, in broad market plunges or euphoric rallies, and other times they are company-specific. My goal is to identify what I believe these mistakes are and to explain my reasons. If at times I seem to tilt into the growth camp, it's simply because the historic tendency of the stock market is to rise. I am by nature reasonably optimistic and I don't expect an imminent apocalypse.

When to Sell
During the recent Nasdaq plunge I advocated buying stocks and outlined the formulas I use to buy into a declining market. Many of you wrote to ask for my approach to selling into a rising market, which may be necessary to ensure that you have cash on hand the next time the market plunges and bargains appear. As I've said, I generally don't try to market-time, and my goal is to have approximately 10% cash at a market high and to be fully invested at a low. The rest of my investment funds remain in the market full time.

It may be premature to talk about a rising market, but let's assume that the Nasdaq low of 3075 reached Oct. 12 marks a bottom and a rally has begun. The median advance in the Nasdaq since 1979 has been 46.75% in a rally lasting nearly a year. For ease of calculation, let's round that to 50%.

My formula is simple: I begin selling at intervals of 25% gains, approximately 5% of my assets each time. I will have reached a full cash position at a 75% gain. The target numbers based on the Oct. 12 Nasdaq close are 3844, 4613 and 5382. Obviously, the thresholds in these formulas can be adjusted to suit your own risk tolerance and the degree to which you want to try to market-time. I use the Nasdaq Index, but you could use the Dow Jones Industrial Average or the S&P 500 just as easily. There are many variations. The important thing is to have an approach and to be disciplined about it.

By the way, a nice thing about selling into rallies, unlike trying to buy into declines, is that you don't run out of cash you can continue to sell if the market soars even higher. But I confess that I lacked that discipline last year, when I felt like a fool selling into the biggest rally in Nasdaq history while my friends taunted me for my timidity. Sitting on cash was painful from January through March, but I should have raised even more. Now, of course, I've vowed not to make that mistake again.

Which reminds me that buying low and selling high, however obvious logically, can be emotionally difficult. You are always swimming against the tide of popular opinion. It doesn't feel good when you buy only to see your stock decline further, as has happened in recent weeks. For me, it feels even worse to sell and then watch your stock continue to rise. It's hard to sit on cash in a rising market, as I learned earlier this year. Yet such is the route to superior returns.

A brief update
After reading this column, many of you wrote to accuse me of "fuzzy math" in my selling strategy. Let me try to clarify the formula. If you sell 5% of your portfolio at intervals when the market registers gains of 25%, 50% and 75%, you will end up with more than the 10% cash that I indicated was my target. Specifically, you end up with 14.26%. But rallies in which the market rises 75% are unusual. Since the average rally is closer to 50%, I will have raised 9.75% cash in the more typical rally, and more than that when the market gains more than 75%.

That said, the fact is that I am not as precise in my actual selling as these calculations suggest. The numbers are guidelines, and I use these thresholds to put myself into a selling mode. But going above or below these targets by a percentage point or two has had minimal impact on my overall returns.