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Stocks Worth Cutting Loose

Sometimes it's best to take the tax loss and move on.

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Breaking up may be hard to do, but sometimes it has to be done. The same goes for dealing with losing stocks in your portfolio. Sure, everything was great in the beginning, when the stock seemed like it would help your portfolio live happily ever after. But since then, things have gone from bad to worse. Now all you have is a bunch of losses and the bitter taste of regret. 

Of course, a stock's drop in price doesn't make it an automatic sell candidate. But if the fundamentals have deteriorated--or maybe weren't that strong to begin with--it makes sense to consider cutting your losses. Another reason to sell is if the stock still doesn't offer enough of a margin of safety to compensate for the risk involved. (For more about when it makes sense to sell a stock, click here.) The end of the year is a logical time to harvest your portfolio for tax losses, as you can use them to offset any realized gains or up to $3,000 in ordinary income. Any remaining losses can be carried forward indefinitely to offset future gains. 

For this week's Five-Star Investor, we began by screening for stocks that have dropped by at least 15% per year over the trailing three-year period. The market has posted an annualized gain of about 3% over the same period, so that's a pretty big margin of underperformance. We also limited the group to stocks that have had negative returns so far in 2004. To avoid penalizing stocks that have been under a short-term cloud but might offer attractive valuations, we then screened for issues with 1- or 2-star ratings. In general, the stocks that passed our screen either trade at a premium to our analysts' fair value estimates or fail to offer a generous enough discount to compensate investors for the risks involved.

Here are some of the stocks that made the cut:

 Infineon Technologies AG (IFX)
3-Year Annualized Return: -18.56%
Year-to-Date Return: -18.45%
Morningstar Rating: 1 Star
From the  Analyst Report: "Infineon's chip business is diversified, but it has limited appeal due to its exposure to DRAM and other low-margin products. As a result, we think both growth and returns on invested capital will be below average over the long term."

 JDS Uniphase (JDSU)
3-Year Annualized Return: -34.01%
Year-to-Date Return: -10.57%
Morningstar Rating: 1 Star
From the  Analyst Report: "JDS Uniphase has a lot of things going for it: the leading position in the optical-component industry, a history of technology leadership, an improving product mix, and a healthy balance sheet. However, the company continues to trundle along with just 20% of the revenue it had in 2001, but its shares are currently priced for a much stronger recovery in telecom-equipment spending than seems likely."

 Cable & Wireless PLC (CWP)
3-Year Annualized Return: -24.04%
Year-to-Date Return: -4.567%
Morningstar Rating: 1 Star
From the  Analyst Report: "We like the changes management has made at Cable & Wireless (C&W) and the stability its large cash position affords. However, C&W's historically poor capital-allocation decisions and the increasingly competitive operating environment the firm faces prompt us to look for a large discount to our fair value estimate before buying the stock."

 Cadence Design Systems (CDN)
3-Year Annualized Return: -17.74%
Year-to-Date Return: -28.48%
Morningstar Rating: 1 Star
From the  Analyst Report: "Cadence Design Systems faces stiff competition for the top spot in the electronic-design automation (EDA) industry. As part of its strategy to reassert its influence, Cadence has championed "OpenAccess," the industry's solution for sharing data among disparate EDA tools by utilizing a standard interface. OpenAccess' success should benefit the chip industry, but we don't think it will significantly improve Cadence's attractiveness to investors."

 Abgenix (ABGX)
3-Year Annualized Return: -33.28%
Year-to-Date Return: -22.35%
Morningstar Rating: 2 Stars
From the  Analyst Report: "Abgenix discovers and develops fully human therapeutic antibodies using its proprietary XenoMax technology. While Abgenix has a pipeline of promising therapeutic candidates, none of its products have reached the market yet. Given the substantial risks involved in the drug-discovery and -approval process, we would require a hefty margin of safety before investing."

To run this screen yourself and see all the stocks that pass, click  here. (The stocks mentioned above passed our screen as of Nov. 12. The results of the screen may change due to daily price fluctuations or other factors.) After clicking, you can save the search for later use by clicking the "Save Criteria" button in the bottom right-hand corner of the screen. (Note: You will need to be a Premium Member to view and save the complete screen.)

Amy C. Arnott does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.