Wednesday, 3rd June 2009

Never sell a stock

Written by George Traganidas Topics: Personal Finance, Stock Investing

One of the biggest challenges that people face when they buy stocks is to decide when to sell them. This decision is as important as deciding which stock to buy. Even Warren Buffet, the legendary buy and hold investor, is selling stocks if he believes that he can find a better place for his capital.

First of all, you should never sell simply because a stock—and the market in general – goes down several percentage points. Selling on this basis alone is an overreaction that usually costs you money in the long run. Don’t waste your time on trying to time the market. Instead, you want to know your stocks well enough to be able to recognize which events spell danger and which scream opportunity.

Here, then, are some pointers to help you decide whether to stay the course or sell—for the right reasons:

1. Stay informed.
For other stocks you may own, make sure you check on them at least once a quarter when they report earnings. You want to read through all of the recent earnings reports and annual reports as well as press releases, magazine articles and online articles. What should you look for? Here are some key areas to research:

  • How the firm is doing with its current operations.
  • New directions the company is heading and any new plans it’s announced.
  • Any cautious words issued by management.
  • Trends evident in financial statements.

The better you know your company, the better handle you’ll have on its overall value and potential profits. This will make you less likely to sell a stock as soon as its price drops, only to regret it when the stock heads up again. The reverse is also true. By staying informed, you’ll be more likely to spot problems sooner rather than later and get out of bad situations before they get worse.

2. Keep track of the reasons you bought in the first place.
Whenever you buy a stock, it’s a good idea to jot down the reasons you believe it’s a good investment. This can boost your confidence in your purchase and assist you in determining when to sell down the road—that is, if some or all of those reasons are no longer valid. Over time, if the company grows properly, you may find some of your original reasons are scratched out and replaced with new entries. Keeping track of a company’s qualities as they evolve will also help stave off any temptation to sell based on emotion.

3. Refresh your memory on longtime holdings.
Again, you want to know the reasons you’re buying a stock before investing. But if there are some stocks you’ve had forever and you can’t remember why you bought them, it’s time to start refreshing your memory. If you can’t find a set of compelling reasons to invest, consider selling.

4. Watch the valuation.
Simply put, you want to know if your stock has room to run. In the bigger picture, if your company has the management and structure to continue growing and reaching new levels of profitability, stay the course. If you’re less than confident that the company is willing to change with the times, move on.

5. Don’t get caught in the percentage loss trap.
Stop losses are essentially a floor that you put under a stock’s price. You can set a limit order with your broker to sell if a stock dips a certain percentage or hits a specific price. On the one hand, stop losses can protect gains and minimize losses. Unfortunately, they are just as likely— if not more likely—to bounce you out of a stock right before the momentum shifts and it begins rising again. The biggest problem with stop losses is that they lock you in to sell based purely on short-term price movement and not on the company’s true potential. Now, you need to be comfortable with the way you invest. If you simply can’t sleep at night without a stop loss in place, by all means set some up with your broker. Be aware, though, that you’re as likely to be burned by them as you are to be helped.

Here are some cases to sell
Now you have an idea of what to do before quick-clicking the sell button when your stock is down. If you’ve invested in the right companies, chances are you’ll stick with
them through the tough times, confident that your future profits will outweigh the short-term ups and downs. That said, you might wonder when we would ever recommend selling a stock. There are many legitimate reasons to sell. First and foremost if a company’s fundamental story changes significantly for the worse, sell. Among the key indicators of this are slowing sales growth, divergent sales and profit growth, and plummeting cash flow. All can be real signs of trouble. Other legitimate reasons to consider selling are:

  • You’ll need the money within a few years. Any money you’ll need in one to five years should be in a less volatile place than stocks—perhaps money market funds, bonds or CDs.
  • You find much more attractive places to invest your money. Aim to have your money invested only in your top ideas—in the companies that seem most promising to you. That said, if you find a company that’s only slightly more attractive than another, it’s often not worth selling and switching because of the taxes that you may owe on any gains in the first stock.
  • You’re only hanging on for emotional reasons. Perhaps your favourite uncle left you some shares of his favourite company—one he worked at for 50 years. If you’re hanging on to them sentimentally, out of love for your uncle, that’s sweet—but maybe not smart. Be objective when you assess a holding’s value and potential. Don’t hang on because a stock was the first one you ever bought, or was good to you in the past. Your uncle would want it that way.
  • You have too much money in too few stocks. Proper diversification is a hallmark of Foolish investing. Focusing your money on a few stocks is simply too risky. If that’s your situation, consider selling some shares and redeploying the money into a few additional companies. Diversification is your strongest defence against a poor performer.

In sum, be smart about how you approach downturns in your stocks. Don’t let yourself get spooked and make bad decisions for the wrong reasons. Instead, do some reassessing and make sure that you own the right companies for the right reasons.

Follow the practical way,
George Traganidas

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