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As the market fell and investors panicked, The Motley Fool held a live chat Monday between Fool readers and our writers and analysts. Among the many questions our readers posed: "How do you know if it's time to sell a loser and go with another stock instead?" There are lots of times to sell, but you need to distinguish between temporary and permanent problems.
The market's deep dives have left investors hyperventilating, their fingers hovering nervously over the "Sell" button on their brokerages' trading platforms. They've just been reminded how volatile the stock market can sometimes be; some of their holdings are down a lot; and they have an urge to take their losses and perhaps swear off stocks altogether.
Frankly, that's a terrible idea. If you're going to invest in stocks, you have to accept that the market will occasionally crash, but that its long-term trend has been upward. Great stocks don't move up in a straight line -- they zig and zag. Jumping into the market when it's been booming a while, and bailing out when it crashes, is a perfect way to lose money. Giving in to greed and fear can deliver you to the poorhouse.
Let's review some of the many reasons why you might sensibly sell a stock -- and move the proceeds into something else.
If a stock's price seems to have gotten way ahead of itself, consider selling. It may now be more likely to fall closer to intrinsic value than to keep advancing. The stock market's recent swoon should make this less of an issue for most stocks. For example, by several measures, Krispy Kreme (NYSE: KKD ) looks overvalued. The company has been turning itself around, but it doesn't appear to be a screaming bargain quite yet.
Of course, some companies, such as Amazon.com, almost always seem overvalued, but they keep advancing year after year. SodaStream (Nasdaq: SODA ) is one company appearing overvalued on a P/E basis, but many Fools are optimistic about its make-your-own-soda-with-our-cartridges business.
Ask yourself how well you really understand your holdings. If you can't explain what a company does and exactly how it makes its money, you may end up with some nasty surprises. Either learn more about the company, or sell it.
Consider Chimera Investment (NYSE: CIM ) . Its business model involves borrowing money at today's very low interest rates, and investing that cash in mortgages. Rising interest rates will eventually challenge its profitability to some degree. The Fed's promise to keep rates low for another two years may make Chimera a safer bet for now, but you still need to understand how interest rates affect this business.
Many times, the reasons we buy a stock disappear. You might have invested in Eastman Kodak (NYSE: EK ) years ago because of its dominance in cameras and film. But film photography has since grown moribund, and Kodak's business model has changed to focus more on licensing its various technologies. You'll need to determine whether that new purpose still makes the company attractive in your eyes.
Alternately, Dendreon (Nasdaq: DNDN ) and its promising cancer treatment, Provenge, may have caught your eye. But the drug's astronomic price tag has proven to be an obstacle, and competitors such as Exelixis (Nasdaq: EXEL ) are working on other prostate cancer treatments. A disappointing recent announcement sent shares down 65%! It's time for shareholders to reassess their confidence in this company.
Paying attention to your holdings can pay off when you spot potential trouble. Advanced Micro Devices (NYSE: AMD ) might look good on the surface, having recently reported estimate-beating earnings. But a closer look reveals worrisome trends, including shrinking gross margins and dwindling sales in its graphics division.
Temporary vs. permanent
Before you sell a stock, ask yourself whether the condition driving you to sell will soon pass by, or whether it's here to stay.
Gobs of stocks have lost a lot of value recently, falling along with the overall market. But much of that drop wasn't related to each individual stock. Automakers' sales didn't suddenly drop 5% or 10%. Delivery companies were not suddenly facing sharp declines in volume. Merck saw its price fall along with the market, but people living with medical conditions won't abruptly stop taking their medications, and the drugs in Merck's pipeline haven't become less likely to win approval.
Your best ideas
When deciding whether to sell, ask yourself whether you're invested only in your best ideas. After all, why put any money in anything other than the companies that inspire the most faith and hold the greatest potential? If any holdings are not your best ideas, consider selling and moving that money into more likely winners.