Saturday, September 13, 2008

One of the toughest decisions: When to Sell

It seams like I can always find a stock to buy but deciding when to sell a stock can be a very difficult decision for many investors. When purchasing a stock I now try to have a plan in place on when I will sell the stock. Kiplingers has a very good article I like to look back on for guidance. The post is called "When to Sell a Stock" and it gives four signs when it may be time to sell a stock. There are no foolproof plans for investing but having a plan for selling and buying can help make the investment process easier.

When to Sell a Stock
To make the decision easier, look for these four signs.
By Cameron Huddleston

The right time to unload shares is one of the toughest calls investors have to make. Even professional traders and money managers admit it can be difficult. "It's a lot easier to buy a stock than to sell a stock," says David Giroux, manager of T. Rowe Price Capital Appreciation fund.

That's because if you sell when a stock is down, you feel like you're giving up, Giroux says. And it rarely feels right to sell when a stock's price is soaring -- even though that can be the best time to sell.

Now, there's nothing wrong with holding a stock 20 or more years -- if it's the stock of an exceptionally well run company, says Giroux, who tends to hold stocks for three to five years in his $10.5 billion fund. But even if you're a buy-and-hold investor, you need to learn to say "sell" sometimes.

The market's recent volatility might be making you want to say, "Sell it all. I'll sit this out until things calm down." But you shouldn't let fear guide your investment decisions. Instead, look for these four signs to help you decide if the time is right.

1. A change in the company's fundamentals. Usually the best clue for when to sell a stock comes from the issuing company, itself. If a company's earnings stop growing, if its top management quits or is forced out, if it stops creating new products, or its products aren't receiving regulatory approval, the company's shares could be headed for a fall. Kiplinger's Portfolio Tracker can help you keep tabs on a company's performance.

One sure sign of trouble is if a company is having cash-flow problems, Giroux says. A cash flow statement gets to the guts of a business -- the cash it receives and the cash it pays out. It's especially handy when researching companies that don't have profits. You can find the information in the company's annual reports, accessible on its Web site, or sites such as Yahoo! Finance and Zacks.

Giroux says look for changes in free cash flow: 1. Is operating cash flow growing slower than net income? 2. Is inventory rising faster than sales? 3. Are receivables rising faster than sales? These are early warning signs that it might be time to sell
the company's stock.

2. The stock's too hot. If a company's stock price is soaring but its fundamentals, such as earnings growth, aren't following suit, it's time to sell, says Jerry Jordan, Jr., manager of Jordan Opportunity fund. A stock with an especially high price-earnings ratio may be the victim of investors' unrealistic expectations. To calculate this familiar measure of a stock's value, divide the current share price by the company's earnings per share.

You can compare a stock's P/E with that of the overall market, the average P/E of its industry, or against the company's past P/Es. If the company's ratio is unusually high, it could have a hard time sustaining that price.

Jordan recommends picking a target P/E when you first invest in a stock. If the price jumps but the earnings keep up, you won't have to sell. This method can help give you the discipline to dump the stock before it becomes overpriced.

3. The stock's not keeping up. The market's rallying, but your stock isn't. This can be a sign to sell, Jordan says, especially for popular or trendy stocks that tend to move in sync with the market. For example, if stock was $100, drops to $80 but doesn't bounce back or even falls below that level, sell.

4. The stock is taking over your portfolio. If you went into your stock purchases aiming for diversification, revisit your portfolio once a quarter to see if your holdings are still in balance. If you have one or two big winners and their futures still look bright, you may want to consider taking some profits off the table -- and adding to your other holdings -- just so you won't be overexposed if the unexpected happens.

Don't put much stock in technical signals

Sometimes investors use technical analysis to gauge when to sell shares. But Giroux says there is no proof these signals are accurate over time.

Among the more commonly used technical signals are the 200-day moving average and the support line. With both, you're supposed to sell when a stock's price falls below a certain point -- regardless of what's going on with the company's fundamentals.

You won't get them all right

Even when the warning signs are there, sometimes it still can be hard to let go of a stock. For example, Jordan says he's kicking himself for holding on as long as his did to shares of Merrill Lynch, whose chief executive was forced out on October 30 after the company announced a $7.9 billion write-down of debt and subprime mortgage assets. In November, Jordan still had 4.5% of his fund's assets in Merrill Lynch, according to Morningstar.

"I realized it wasn't working, but I had no idea they were doing as bad a job managing their money as they were," he says.

Ideally, you sell a stock when it's up so you can make a profit. But sometimes you have to cut your losses and sell when a stock is down.

Remember, you get a break on capital gains taxes if you've held the stock at least a year (a 15% tax rate for most people). If you're sitting on a loser, there's even a consolation prize: Losses offset capital gains -- from other sales, for example, or mutual-fund distributions -- and, if you have more losses than gains, up to $3,000 of net loss can be deducted against other kinds of income.


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5 comments:

  1. I sell in a few different situations:
    - Once a stock has hit my target price
    - Fundamentals change occurs
    - When a portion of it exceeds 5% of my portfolio
    - After a quick/sudden short-term upswing

    Most often I look to re-enter a position later on, but you only make money when you sell & you have to protect yourself as an investor.

    Great article by the way!

    ReplyDelete
  2. #1 and 2 are good reasons, but I don't really agree with 3 and 4.

    With 4, if the future seems bright, why sell when you should be adding more or keeping it.

    And the most difficult reason to sell I found is selling when you realise you made a mistake.

    ReplyDelete
  3. The list is just to get people thinking about selling strategies. I use some rules but I often make exceptions.

    ReplyDelete
  4. I enter a Stock with the hopes to hold it forever. It would have to be severly overpriced for me to use that as a reason to sell. Everyone invests for different reasons though.

    ReplyDelete
  5. I also think that my holding period is forever. But if a stock constitutes a large portion of my portfolio i might consider rebalancing.

    Other than that, selling based off of fundamental factors is a recipe for distaster because stock prices are always a leading factor. If you sell when you notice a deterioration in fundamentals, the market might have already fallen for months anticipating the negative news.

    Oh yeah, I think that selling stock should be prohibited fror long-term investors. Check this out:

    http://www.thediv-net.com/2008/07/ultimate-passive-investment-strategy.html

    this study shows that it pays to purchase a diversified mix of stocks and then forgvet about it for 50 years.

    ReplyDelete

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