4 Reasons to Sell a Stock

The hope of profits and the joy of ownership make buying stocks a fairly simple decision, especially in comparison to the tormented hair-pulling that's often associated with selling.

When to jettison a stock is a difficult decision, so we won't pretend there's a one-size-fits-all formula. However, guidelines can make selling decisions easier. At Motley Fool Pro, the following are four key factors in any sell considerations.

1. Valuation
The most cited reason to sell – a fairly valued stock – is also the most difficult to nail down.

We estimate the fair value of a company before plunking money down to buy, determining intrinsic value by digging into financial statements, analyzing business prospects and free cash flow, and making conservative assumptions about future growth.

Buying undervalued stocks, we wait patiently for a price that's close to our estimate of fair value, reassess at that point, and then ruthlessly sell if the stock looks fairly priced. Having personally bought MasterCard (NYSE: MA  ) in the past around $150, after it cleared $220 -- nearly a 50% gain for a large company -- the stock looked fairly priced. It was difficult to sell such a strong business, but it was the right move. With the stock at $163 one year later, I can consider buying again.

It's not always that easy. Amazon.com (Nasdaq: AMZN  ) has looked expensive for years, but continues to reward shareholders. If valuation is perplexing you, you need to consider selling just some of your shares (to lock in profits), or protect your gains through other means, and then consider other factors in your sell decision.

2. Fundamental Change in the Underlying Business
Companies are always undergoing change — sometimes for the better, oftentimes not. As patient investors, we're willing to tolerate minor, fixable hiccups along the lines of a weak quarter or delayed product launch. We're not so forgiving of major blunders — think acquisitions that undermine the core business, getting surpassed by a competitor, or a string of failed expansion attempts. Pfizer's (NYSE: PFE  ) acquisition of Wyeth (NYSE: WYE  ) was questionable enough to make many sell. Whenever a business undergoes a significant change, you need to put on your thinking cap and reassess.

3. Challenges to Your Investing Thesis
When you make a buy decision, you should write down your reasons and keep them handy. Knowing the most important drivers behind your buys, you can reassess your decision if any part of your thesis is challenged.

Because valuation is part of any thesis, threatening changes can include dividend cuts, deterioration of margins, weakening free cash flow --- or economic shifts. At Pro, we keep the Big Picture in mind. If you'd bought Home Depot (NYSE: HD  ) believing a housing boom would continue, you'd follow housing news closely and may have seen your thesis falling apart -- forcing a timely sale. So, what's the thesis behind each stock you own? Write it down.

4. Better Places for Your Money
Sometimes a sell decision has little to do with the holding itself — you may simply see better opportunities elsewhere and lack the funds to take advantage. Just as a soccer coach will swap tired players for fresh ones in order to win the game, your portfolio can benefit from shuffling some players, too. In the late 1990s, it was becoming apparent PepsiCo (NYSE: PEP  ) was making headway while Coca-Cola (NYSE: KO  ) was struggling – and Pepsi was the cheaper stock. Since 1998, Pepsi has gained 50% while Coca-Cola has lost 24%. That was a great swap.

Just like the five traits of great stocks we keep in mind when we buy, these are some of the criteria at the forefront of our sell decisions at Motley Fool Pro. We launched in October 2008, so we're young, but each position we've closed has been profitable and market-beating.

To keep membership manageable, Motley Fool Pro will open for a few days this month and won't reopen again until 2010. Join us while you can – and let us sweat out the tough sell decisions for you. You can get more information about Motley Fool Pro right here.

Jeff Fischer is the advisor of Motley Fool Pro, and owns no companies mentioned in this article. Amazon.com is a Stock Advisor selection. Coca-Cola is an Income Investor and Inside Value pick. PepsiCo is an Income Investor selection. Home Depot and Pfizer are Inside Value picks.


Read/Post Comments (10) | Recommend This Article (88)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 18, 2009, at 9:03 PM, malibusean01 wrote:

    OK, I get it that you want to buy when a stock is undervalued but sell it when you feel it is fairly valued.? I can remember before this financial crises that you wanted to sell when a stock was OVERVALUED not just fair valued. Has this market shell shocked us so much that we are happy to profit from a fairly valued stock instead of waiting till market optimism is at its max for your stock? I guess that idea is gone along with long term buy and hold.

  • Report this Comment On June 19, 2009, at 12:27 AM, 33alpha wrote:

    What a nice piece of work. In an industry teeming with advice that is typically repetitive, convoluted, contradictory and outright sophomoric, it is refreshing to read an article that is straightforward, logical and well reasoned.

  • Report this Comment On June 19, 2009, at 7:03 AM, dquihote wrote:

    Great article! with so much focus on when to buy stocks, the sell side gets left out. Yet, this is where we actually make the profit to take home. More articles like this - detailed, specific, and informative would be a great asset for MF!

  • Report this Comment On June 19, 2009, at 7:05 AM, dquihote wrote:

    Follow up on above comment:

    details I would like to see explained in more depth include, but are not limited to: definitions of fair value and valuation. How are these determined?

  • Report this Comment On June 19, 2009, at 7:36 AM, garyegreen wrote:

    I'd add a fifth -- any indication of shenanigans on the part of senior management. (playing fast and loose with the numbers; significant legal problems; building a mansion in Flordia 8)

  • Report this Comment On June 19, 2009, at 10:36 AM, catoismymotor wrote:

    Jeff, thank you for laying it out for us in such an easy to read manner. Your artilcle should be printed and placed in a picture frame and kept in a place of prominence.

  • Report this Comment On June 19, 2009, at 10:48 AM, evilrage wrote:

    Great article! Everybody has to sell sometime - after all, if you hold 'forever' then you'll never be able to enjoy your gains (or risk losing it all, like some did over these past few volitle months).

    I agree with dquihote above - I'd love to find out some in depth ways to determine fair value and a stock's current valuation. How do you guys do it?

  • Report this Comment On June 19, 2009, at 10:49 AM, evilrage wrote:

    Wish there was an 'edit post' button or a spell checker... I swear I know how to spell volatile...

  • Report this Comment On June 19, 2009, at 12:11 PM, summerhaven wrote:

    need to know if it's too late to begin accumulating cme

  • Report this Comment On June 19, 2009, at 4:17 PM, TMFFischer wrote:

    Hey Fools -- thank you for your comments.

    To answer some: At fair value or when overvalued is when you want to start to exit (or at least consider selling) positions, of course, but I purposely wouldn't wait for a stock to become overvalued. It may not reach such a price, in which case getting a fair value for your stock is the most you should seek. Writing covered calls on the shares to sell a bit higher can be a good strategy when you're confident the stock won't fall much.

    I definitely still believe in long-term investing, but obviously it is (and always has been) largely about buying good companies at "low" or value-creating prices, and then selling when the prices are at value-destroying types of levels (when the odds are high that the share price will be lower even a number of years from now). You sell at that point whether it has taken 20 years to get there, or two months.

    We estimate fair value on stocks by running discounted cash flow models under different scenarios (basically cautious, moderate and aggressive scenarios). No DCF model will be perfect, so it's an estimation. You can't invest to be perfect either, but just need to invest well enough to make money.

    Foolish best,

    Jeff

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