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Even Warren Buffett, “Mr. Buy and Hold”, sells. He has dumped holdings in Freddie Mac, Fannie Mae, McDonald’s, Disney, Guinness, Travelers and USAir. Although the great man rarely gives reasons for jettisoning stocks, Buffett has laid out his general rules for selling. In his 1987 letter to Berkshire Hathaway shareholders, Buffett wrote that he would sell a holding when the market overvalues it -- in other words, when it rises to a price well beyond what he thinks it’s worth. He’d also sell, even at a loss, to raise money for a potentially more lucrative opportunity Buffett summed up his selling strategy this way: “We are quite content to hold any security indefinitely, so long as the prospective return on equity capital of the underlying business is satisfactory, management is competent and honest, and the market does not overvalue the business.”
The lesson to learn from Buffett? You need a disciplined sell strategy.
Here are 10 potential sell signals.
For each of your holdings, ask yourself, “At this price, at this P/E and with its current prospects, would I buy this stock now?” If you wouldn’t buy it, why should you continue to own it?
The stock‘s P/E climbs to more man 50% above its historical average, the industry average or the S&P 500’s average. (If it’s above all three, don’t hesitate.)
The CEO or CFO unexpectedly resigns or is fired. (A board member quitting is also an alert.)
Declining profits, either actual or projected, over a three- to five-quarter period.
The quality of earnings is deteriorating. Net profits, for example, may be expanding, while revenue stagnates for more than two quarters. And, these days, we don’t have to remind you to bail at the first sign of accounting irregularities.
An unexpected surge in the price of the stock that gives you a return of 50% or more in just a couple of months. A rocket like that has probably gotten ahead of itself, and it’s wise to take at least some of your profits.
The stock drops by 25%. If you sell part of your stake as it plummets, you’ll safeguard some of your investment should the stock fall into an Enron- or WorldCom-style abyss.
The investment story has changed. The company is losing ground to a competitor, for example, or it has lost a major customer.
You’ve found a better potential investment.
You need to offset a capital gain with a capital loss. This is the least important reason for selling, but it’s still valid.
Pablo Galarza, Money magazine, September, 2002.
If you have questions or comments, write to: DIGnet@mindspring.com.
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