Diversity Investment Group When To Sell Stocks

by Ray Anderson  (BetterInvesting On-Line)

1. The best time to sell is NEVER, or so says Warren Buffett.
   1. Deciding to sell involves as many decisions as deciding to buy.
   2. If selling to buy a replacement stock, 2 GOOD decisions must be made.
      1. Sell the stock for legitimate reasons.
      2. Buy a stock with less downside risk and greater upside potential.
   3. With commissions and taxes, on average, new stock must gain 37% before making money.

       

2. There are legitimate non-performance-based reasons for selling.
   1. Sell to reap the financial benefits of years of prudent investing.
   2. Cash out departing investment club partners.
      1. Better to transfer stocks than to sell them; no capital gains in transfers.
   3. Sell losers for capital loss, to be used for income tax purposes.
   4. Must sell to maintain adequate diversification.
      1. In small portfolios (less than $100,000), any stock should not account for more than 20% of total value of the portfolio.
      2. In large portfolios (greater than $100,000), any stock should not account for more than 10% of total value of the portfolio
      3. Ideally, to maintain diversification, preference would be to purchase more of other, smaller-value stocks rather than sell higher-value stocks.
         1. Be wary of selling high quality growth stocks. Your greatest returns may still lay ahead.

             

3. Before selling understand why you buy.
   1. Sales & earnings are growing at a rate in excess of the economy.
   2. Profit Margins are maintained or are rising.
   3. Current P/E ratio is equal to or less than 5-yr average P/E.
   4. Upside/Downside Ratio is 3:1 or better.
   5. Projected Total Return is acceptable to your investment goals.
   6. Management is competent & continues to make the "right" decisions.

       

4. Selling decisions are opposite of those used in buying stocks.
   1. Sales or earnings growth stalls.
   2. Profit Margins are declining.
      1. International markets with lower operating costs.
      2. Labor disputes, eg UPS: full-time vs part-time labor costs.
   3. Current P/E ratio is higher than 5-yr average P/E.
   4. Upside/Downside Ratio is 1:1 or lower.
   5. Projected Total Return is unacceptable to your investment goals.
   6. Management decisions indicate incompetence or neglect.
      1. New management may not necessarily be better management.
      2. A drop in the return on invested capital affects the investor.
         1. Different stocks, as well as different investment vehicles compete for investor money.

             

5. Other valid reasons for selling.
   1. A deteriorating corporate financial condition.
      1. Excessive debt jeopardizes principle & interest payments.
   2. A stock's response to changing economic circumstances.
      1. Products fall out of favor, eg: buggy whips.
      2. Costs of raw materials change dramatically, eg: Rubbermaid.
   3. A company is dependent on a major customer for a substantial amount of its revenues.
   4. A company is a One-Product company, eg: WD-40.

       

6. Wrong reasons for selling.
   1. Selling because the price hasn't moved
   2. Selling because of a paper loss or a paper profit
   3. Selling because of temporary bad News
   4. Selling just to take action
   5. If you've kept a stock while it plummeted, don't sell it when it has fallen so far that any remaining downside risk is minimal, compared to its upside potential.
   6. Selling by using Price Targets, eg: automatically selling when stock has doubled or when it has dropped by a certain percentage.
      1. Any drop in price should flag the stock for further analysis; it should not, however, cause an automatic sell ... understand why things happen.
      2. If a stock has doubled, hold it to triple or quadruple.

          

7. Wrong reasons for NOT selling.
   1. You're emotionally attached to a company.
   2. You hate to admit that you made a mistake.
   3. You hate to take a loss, and you want to wait until the price rises back to the purchase price.
   4. You don't know how to take advantage of a loss for tax purposes.

       

8. Conclusion
   1. Selling, like buying, is not an easy decision.
   2. You must look at the whole picture, not just at one or two numbers.
   3. If 4 out of 5 selling decisions are correct, you should do well.

If you have questions or comments, write to: DIGnet@mindspring.com.

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