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.
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.