When To Sell A Stock?

Executive Summary:



The Art of Selling

 

If your stock drops 10% should you sell? What if the stock goes up 10%, do you take the profits or wait and see if the stock continues to rise? An area that isn’t well covered in the investing world is the practice of knowing when to sell a stock. Investing is such a nebulous field to begin with that most people focus all their attention on just trying to figure out what to buy. Determining when to sell is nothing more than an afterthought. As a long-term buy and hold investor I don’t plan on turning over my portfolio often, but every once in a while it makes sense to harvest some gains or jettison a loser.

 

Investing is more of an art than an exact science and as such there is no right or wrong answer in determining the best time to sell. However, having a plan of action will help inject some logic into this important decision, which can be the difference between making a profit or taking a fat loss. I’ll walk you through my strategy and hopefully you can apply this to your own investing.

 


Know Why You’re Buying

 

The first important step in knowing when to sell actually begins before you even buy the stock. There’s a lot of retail investors out there that have absolutely no idea why they own a particular stock. Purchasing based off of a hunch or advice from a co-worker usually doesn’t end well. There needs to be some real analysis, preferably supported by this thing called data, that was done in order to determine which stocks to buy.

 

 

Having a list of reasons outlining why you made the purchase will help set-up the framework of when to sell. For example, lets say I buy McDonalds stock because my analysis lead me to believe that it was dirt cheap, even though I think the future of the business is headed towards extinction. My reason to buy would be based purely on valuation, which is a short-medium term arbitrage opportunity between price and value. This means once McDonalds stock price hits my valuation target, that would be my signal to sell and get the hell out of there. I don’t want to hold onto the stock longer than I have to. Pretty straight forward.

 

But let’s take a look at another example. I’m analyzing Apple stock and I conclude that the business is slightly undervalued. However, the company maintains high customer loyalty and is planning to launch some revolutionary products over the next few years, which means the future looks really bright for Apple stock. In this case, I would buy Apple based partly on valuation, but also partly based on the long-term quality of the business. So when the stock price hits my valuation target, I probably wouldn’t be motivated to sell right away. I know Apple has a bright future a few years from now and the value of the business has room to grow. As you can see in this second example, selling Apple stock isn’t as straight forward.

 

The reasons why you originally bought the stock will help guide you on when to sell and this is usually rooted in the type of stock you’re buying. If the stock was bought purely on the basis of cheap valuation then determining when to sell is pretty easy. But the decisions become much more fluid if you focus on buying higher quality companies with long-term growth potential.



It’s Complicated…

 

The three main reasons professional money managers decide to sell are: the story has changed (ie. new management, acquisition, declining sales, etc.), investment thesis is proven to be wrong, or there is a better opportunity to deploy capital. These are all important factors to consider before you sell, but take notice that none of these options give you an exact price at which to sell. The main focus at this point shouldn’t be determining an exact sale price down to the last penny. The way most fund managers view the exiting of a position is, “Hey – we bought Apple stock at 9x P/E and sold at 12x P/E, pocketing a 3x profit”. They’re not worried about being exact. Its not worth losing a thousand bucks (or more) just so you can squeeze an extra penny out of the sale price. If you’ve determined that you don’t want to hold the stock, then execute a trade and move on. Don’t get too fancy with trying to exit a position.

 

When in doubt take a step back and look at the company from a high level point of view. Do you feel comfortable holding this stock for another 5-10 years? If not, then unload that sucker. But if its a stable company that can produce decent profits, then it might be worth holding onto. One thing to remember – don’t sell your cash cows!

 

I personally conduct a shit ton of analysis on a company before deciding on when to buy. I have strict investment criteria and I’m pretty anal about what I invest in, which limits me to buying only a handful of stocks throughout an entire year. By the nature of my strategy, I really have no urgency to sell since I maintain a long-term view and conduct thorough analysis before pulling the trigger on a company. This is especially true if I’m just going to sit on cash with no immediate opportunities to invest that money. I like to look at the situation holistically, and I consider valuation and the long-term outlook for the business as my key decision drivers in addition to other investment opportunities available in the market. An important question I like to ask myself is: Are there any better opportunities to deploy capital and earn a higher return?

 

Final Thoughts

 

Selling a stock is an imprecise art that can’t be fully quantified. There are a lot of qualitative factors that need to be considered. The most important step is knowing the stock you’re buying and what your intentions are before you make the purchase. From there, you just have to be opportunistic and consider your options. If the stock presents a credible risk to your portfolio then I would recommend selling and sitting in cash until a better opportunity comes along. You’re better off generating minimal interest from the bank than losing a large sum of money from owning a deteriorating business. Factor in the valuation and the long-term outlook for the business and see how that compares to other opportunities in the market.

 

The best professional investors I follow don’t have any hard and fast rules on when to sell a stock. This is probably what frustrated me the most once I was able to consistently pick stocks that go up over time. I never knew whether I should dump it and move on or keep riding the profits. There will always be those opportunities where you could’ve made a lot more money if you held onto the stock and vice versa. The market is very humbling in that regard. The best thing you can do is to let logic drive your decisions and not emotion.

 

If you have any strategies on determining when to sell a stock, please leave a comment below. I would love to hear it!