Wednesday, September 15, 2010

When to Sell

When you buy a stock, the ultimate goal is to realize a profit by eventually selling it. While there is a plethora of information on selecting the right stock and determining when to buy it, the subject of selling remains somewhat ignored. Prudent selling, like buying, is an art that requires a strong stomach, thorough analysis, and faith in your decision. Waiting too long to sell a stock and seeing the price drop or dumping too soon and seeing the price rise is just as painful as making a buying mistake. With that said, here are some good (and not so good) reasons to sell:

Good Reasons To Sell

You have achieved your goal

Oftentimes when buying in a stock, you determine an exit point. This may occur if you invest in a company that is trading at a significant discount to its net asset value, or some other “cigar butt” situation. In any case, if the stock price has hit your target, then you should take your profits and sell.

You realize you made an error in your analysis

Before investing in a stock, you have hopefully carefully scrutinized the company’s financial statements. You have looked to make sure it has a healthy balance sheet, it is consistently profitable, it has growth potential, and it is an overall quality business. However, you may realize after you have purchased the stock that you have made a mistake somewhere. You may have overestimated future growth or profit margins, and it may or may not have already affected the stock price. Nonetheless, it is best to get out in this case.

High valuation

You may be invested in a truly superb business that has performed well in the past and is poised to do well in the future. However, if everybody else is similarly optimistic or even euphoric about the prospects of the company, then there is a good chance that it is highly overvalued. If you have done a valuation yourself and the current market price is significantly higher than the fair value that you’ve determined, then it might be time to trim your position or even sell the whole thing and wait for a more appropriate entry point.

The company is losing its long term luster

The best companies to own are those with strong competitive advantages in industries that are projected to grow well into the future. These advantages don’t hold forever though. If they did, then Sears and General Motors would still be thriving components of the Dow. If you can see that the company’s economic moat is deteriorating due to higher competition or some new technology that is threatening its livelihood, then you should consider selling the stock.

You found a better opportunity

This is my favorite reason to sell a stock. If you’ve found some other stock that you believe has fantastic potential but you don’t have enough cash to buy it, then you should sell your stock with the least promise to fund the purchase. You may only need to sell a portion of your holding, but you can rest assured that your overall return will be greater as a result if your analysis is correct.

Bad Reasons To Sell

The stock price is volatile

If you have done your analysis and are confident in the price at which you bought the stock, then you should do your best to ignore short term volatility. If the market overreacts to quarterly earnings or if the price unexpectedly drops five percent, you should not be deterred as long as your original convictions about the stock still hold.

The stock price is stagnant

For me, impatience is a greater sin than skittishness. If you’re concerned that the price “hasn’t moved” in a while and you’re not getting immediate results after buying the stock, you need to reconsider why you invested in the first place. If you invested at the right price with the intention of being a long term holder, then you may have to endure a couple of years of stagnation. You will be rewarded in due time, but getting bored and selling the stock is no way to profit for the long haul.