When to Sell a Stock
Deciding to sell is often more difficult than deciding to buy. No unconditional rules nor guarantees exist for determining when to sell. Undoubtedly, the stock will go up after you sell, but if you keep it, it will go down. Buying a stock at its low and selling it at its high is mere luck. It rarely happens, but when it does, it creates a feeling of expertise. Don’t despair nor chase rainbows. You can make a great deal of everyday money by leaving the top 15 percent and the bottom 15 percent for other investors and taking the 70 percent in the middle. Of course, you still have to decide when to sell to capture the middle 70 percent of the price increase. In the absence of retroactive investing, the following three sound reasons for selling can guide your decision making:
1. Sell to correct a mistake.
2. Sell to exit a deteriorating company.
3. Sell to take a profit.
Correct a Mistake
Admitting a mistake and selling a stock can be difficult to do. One tends to put off taking that step. But after all, you analyzed the company with past data, not a crystal ball. Acknowledge the misstep—yours or the company’s—and sell. Don’t wait for the flaw to fix itself. When egos and emotions get in the way, little slips turn into huge falls. Take losses while they are small. A 12 to 15 percent loss will not ruin your portfolio. However, a 30 to 50 percent loss can seriously damage it. The four most overused investment words are, “It will come back.” The reality of percentage decreases versus increases is that a 25 percent decline requires a 33 percent increase to break even. A 50 percent decline requires a 100 percent increase to break even. Will the stock’s price go up 100 percent just to get you back where you started? Rarely. Prosperity is taking losses while they are small. You are a more successful investor after you have taken the loss and reinvested the remaining funds. Selling your losers is like weeding your garden.
Exit a Deteriorating Company
Sell when you see signs of company weakness despite a good economy. The following are indications the company may be having difficulty:
• a decrease in the earnings-per-share, revenue, and dividend growth rates;
• a decrease in earnings for two consecutive quarters;
• a decrease in the profit margin (Company costs have gone up.);
• a decrease in the company’s fundamentals (They have fallen below the industry average or below those of similar companies.);
• an increase in the accounts receivable growth rate compared with the revenue growth rate (The company may be concentrating on moving goods out the door by easing credit, giving incentives for buying now, and using hard-sell tactics. Purchasers may return these goods.);
• an increase in the inventory growth rate compared with the revenue growth rate (The company may be stuck with goods it can’t sell. The company may have to reduce prices or write off the inventory. Both actions will decrease earnings and profit margins.);
• a downgrading of the company’s debt rating;
• an increase in the debt-to-equity ratio without profitable acquisitions or expansion;
• a change in the economic cycle and both the company and industry are declining;
• a shareholder class action law suit has been filed against the company;
• an SEC investigation has been initiated.
If the signs of trouble appear to be longer-term—more than a year—sell and invest in another company. If the company is no longer the good company you bought due to poor management, the economy, or problems within the industry, sell the stock and reinvest your money in another quality company.
Take a Profit
Sell a stock to take a profit:
• its price has reached the upside target you set at the time of purchase.
• you have doubled your profits within six months.
Sell a stock when it becomes significantly overpriced:
• the stock’s p/e is above its 10-year high.
• the stock’s p/e is three or four times the company’s 5-year earnings growth rate.
Summary
The decision to sell a stock can be difficult to make because your ego and emotions are often part of the decision. Yet, ignoring a deteriorating stock and making no decision may be a negative decision by default. Prosperity is taking losses while they are small. Be pro active. Set your emotions aside and sell if you need to correct a mistake, if the company is deteriorating, or if it is time to take a profit. Step forward to success.
Citigroup and Bank of America down 6% and JPMorgan down 7%.
