It’s been said that in value investing, just like in real estate, you make your money when you buy not when you sell. Of course, the sound logic behind this thinking is that if you buy low (which you should), that very action creates the opportunity to sell high. In other words, if you don’t buy low you can’t possibly sell high.
Well, if buying low is the name of the game (and it is), then what is the name of the other game? In other words, when should we think of selling stock? Just when it is high?
But before we go further, some background…
Warren Buffett has said many times that his favorite holding period is forever. I wholeheartedly agree with this logic. Ideally I don’t want to sell any of my holdings, ever. After all, if my horse is winning the race, why would I want to run up the other side of the track and shoot it in the head? Clearly, I wouldn’t. Selling it would cut-off any future gains and it would also create a taxable event for me (yuck). Also, I want to be buying the types of stocks that I would be comfortable holding forever. This is the heart of investing and what separates the investor from the speculator.
Now, some of you may be wondering this – “how the #$%! do you make money if you’re not selling stocks? Don’t forget our good friend, dividends! And don’t forget about our even better friend, increasing dividends! Also, I do sell stocks on rare occasions. The point is ideally I don’t want to for the reasons mentioned above.
With all that said, you should know that selling your stocks should be, and is, a very personal decision for you, and only you, to make. Everybody’s situation is different and subsequently, there will never be a one-size-fits-all guide to selling stocks.
Also, I’m a big believer in the Socratic method of learning about investing. You have to live with the results of your investing decisions, so you shouldn’t take advice from anyone (including me) about when you should, or should not, sell your stock. Do your own homework and make your best decisions is the key to becoming a successful investor. This therefore, is not a guide for when you should or shouldn’t sell your stocks. Rather, this is an essay of things to consider should you want to sell your stocks. Got it? Cool.
Now let’s get into the situations where you may want to consider selling stocks.
- Selling because the investment has met its objective. Your investments have objectives right? Great! We do invest for a purpose my friends. For some it’s to fund their retirement so that they can be financially free. And what about after your retirement is funded? Investment objectives can then run the gamut, from funding a child’s college education to buying that summer cottage in the Hamptons you’ve had your eye on. Don’t forget that the objective of investing is to provide the resources for you and your family to live a good life. When you reach the point that your investments have met their objectives you may want to sell, and you should sell without regret. Remember, saving for goals such as these is why you own stocks in the first place.
- Selling because something has gone wrong. This will happen. When you invest in a specific stock, you make assumptions about the company’s fundamentals and opportunities. Then something happens and you realize that your assumptions were wrong or what happened materially changes the prospects for the company. In the book, Common Stocks and Uncommon Profits, Philip Fisher wrote, “It is only occasionally that there is any reason for selling at all.” That occasional reason is “the deterioration of a company’s underlying business.” In Fisher’s view, there were only two possible causes of a deteriorating condition: bad management (which usually meant a change at the top isn’t working out) or decreased prospects for a company’s products. If you reexamine the stock as if you were analyzing it for the first time, ask yourself this question: based on the new information, what is the company now worth? A lot of times you may have bought the company cheap enough that even new bad news was already priced in, so you might do nothing (which is a decision). However, if you find that, based on new information the company’s future prospects are permanently impaired from when you first bought the stock, you may want to consider selling. Please note, I’m not talking about temporary, albeit significant, hiccups in a company’s stock. That happens too. I’m referring to permanent, material changes to the long-term prospects of the company. A crude example would be a company that just sells typewriters doing business during the onset of the computer boom. Clearly, the company’s long-term business prospects would have been at risk due to technological and competitive changes at the time. So, do your homework to make sure you’re separating common market fluctuations from permanent changes to the underlying company before making any decision to sell.
- Selling because a stock has reached its full potential. When you value a company, you’re looking to see if the stock is currently cheap but you’re also trying to determine its maximum potential as well. Now, this is always part art and part science and is something that successful investors continuously reassess as new information comes in. As Seth Klarman, founder of The Baupost Group and one of the world’s top value investors, explained: “There’s no such thing as a value company. Price is all that matters. At some price, an asset is a buy, at another it’s a hold, and at another it’s a sell.”. It’s very possible that after time, the stock you bought low many years ago has reached its full potential based on your analysis and that may be a reason for you to sell. If so, congratulate yourself on a job well done, but remember this – be humble. Don’t take that as evidence that you are smarter than the entire market. Rather, that your analysis was correct. As Buffett says, “You are neither right or wrong because other people agree with you. You are right because your facts are right.”
- You find another stock that offers better returns. This happens as well, especially given #3. Say you bought XYZ stock in the Great Recession and you now believe its reached its full potential. As you look at the investment landscape, you’ve identified other stocks that have a lower downside but a much higher upside. You may want to swap one stock for another. The idea here is that stocks in our portfolio need to compete somewhat with external opportunities (stocks that you don’t own). Please note, this doesn’t mean heat chasing or financial promiscuity. Those are the signs of a speculator, not an investor. What this does mean is being aware of external opportunities and how they compare to your current portfolio. Now, someone of you may be squirming in your seats a little at this, because it can be seen as talking out of both sides of my mouth – “buy the types of stocks to hold forever” and “perhaps sell stocks if you find something better”. The point here is that things change and it’s good to continually assess things. As an investor, you have to continuously do your own homework and make the best decisions you can. You will make mistakes, but that’s were learning comes from!
I’m often asked which is harder, buying stocks or selling them? Without a doubt, it’s selling them. As an investor who loves to simply buy, hold and collect returns from my investments , I usually hate the idea of having to sell one of the stocks in my portfolio. After all, I’d like to think that I invested in good companies that didn’t ever need to be sold.
But sometimes, even stocks that have delivered years of solid returns lose their stride. Other times, a good company may become mediocre. And then there are times when you discover you chose a dud of a stock instead of a treasure. There’s also times when an investment has realized its potential or achieved a certain objective you had in mind when you made the investment.
The point of this essay to provide you with some information that can be used in your own analysis. Remember not to judge your selling by whether or not you are selling at the top. Instead focus on selling for reasons dictated by your rational reasons of valuations, fundamentals, other opportunities and price.
Be free. Nothing else is worth it.
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P.S.S. What’s this got to do with you? If you don’t take action, absolutely nothing. But remember this – most people fail to achieve what they want in life simply because they never start. If you’re ready to escape the rat race and live life on your terms, don’t wait. Start today.
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