Time to Sell and Lock In Your Gains

A whopping 81% of the stocks in the S&P 500 are in positive territory this year. The stocks of companies like Ford (NYSE: F  ) , Goldman Sachs (NYSE: GS  ) , and Apple (Nasdaq: AAPL  ) have all more than doubled this year. And it's not like these are some tiny micro caps -- these are all multibillion-dollar companies!

Which means it might be time to take some money off the table.

But knowing when -- and how -- to sell is one of the most difficult investing decisions you have to face. It's much more difficult than deciding whether to buy a particular stock.

But just ahead, I'll outline four key criteria you should use when determining whether you should sell a stock, and then spell out two different ways to do so. But first, let's look at why it's so tough to let go.

Breaking up is hard to do
Cognitive dissonance makes us uncomfortable. Really uncomfortable.

Cognitive dissonance is that feeling you get when you know you shouldn't do something, but you also know that it feels damn good. It's the feeling you get when deciding whether or not to order the 1,420-calorie Hardee's Monster Thickburger. It's also the feeling you get when you're up 100% on a stock that you were once down 50% on. You swore you'd sell when you broke even, but now you're thinking of holding on for another 100%, or maybe another 200% ... on second thought, maybe you'll just wait and see where you are six months from now.

If you've ever been in that last scenario (if you're like me, you're probably going through that process with your portfolio right now), it's a good idea to have hard-set rules for when to sell a stock. That way your easily swayed emotions don't get the best of you when it really is time to move on.

Here are four criteria that you should use when determining whether or not to sell.

1. Better opportunities
Whether you're up, down, or at break-even with a stock in your portfolio, if you come across a more attractive opportunity, you should seize it.

What qualifies as a more attractive opportunity? Two things: A stock that's more undervalued than a current holding, or a stock that's valued about the same, but has a lower level of risk.

For example, let's say you own a small-cap stock like Cell Therapeutics (Nasdaq: CTIC  ) , and you're up nearly 200%. You think it still might be about 10% undervalued. But you also have been looking at ConocoPhillips (NYSE: COP  ) , which you think could be as much as 25% undervalued. At this point, it would make sense to take your already-high gains on Cell Therapeutics and snap up shares of ConocoPhillips.

2. Valuation
It's a smart move to have some rules in place regarding a company's valuation. Amazon.com (Nasdaq: AMZN  ) might have seemed a reasonable investment at its recent 52-week low, when it was trading for 23 times earnings. But now that it's trading for almost 80 times earnings, it's not nearly as attractive, and might be overvalued. If you have an undervalued company you've been eyeing, it'd be best to sell Amazon and buy it instead.

3. The business changes
There's only so much you, as an outsider, can know about a company. Most day-to-day business is out of your control. Take the shake-up at Satyam Computer Services (NYSE: SAY  ) earlier this year. When it was announced that executives were engaged in accounting fraud, assumptions you had about past business cycles, the current state of business, and even expectations for the future were no longer trustworthy. In this scenario, it's usually best to take your losses or gains and move on.

4. Wrong investment thesis
When you're looking for companies, you want to find ones that are undervalued and that have a strong catalyst for growth. If your thesis for investing in a company was a potential growth opportunity in China, and then it comes to light that the company is scuttling plans to enter that international market, your thesis is invalid. It's tough to admit that you were wrong, but it's best to humbly admit your error and move on to better opportunities.

Just letting go
When you are ready to sell, you can either do so gradually, or do so completely. When it's a valuation issue, it's usually best to move out of the position gradually, in case the stock still has more near-term upside. But when the business radically changes, your investment thesis is wrong, or you see a clearly better opportunity, selling in one fell swoop is often the best move.

Even though this is the criteria I use when deciding whether or not to sell, the criteria I've outlined above is -- truth be told -- not something I've come up with myself. Rather, I've adopted it from the team at Motley Fool Million Dollar Portfolio.

The team members use these four reasons when deciding whether to sell a stock in their real-money newsletter service. Not only do they tell members exactly when to begin forming a position in a company they find attractive, but also they perform the more difficult task of telling members exactly when to sell, using the unemotional criteria I just shared.

If you're interested in monitoring their live, real-time, real-money advice, MDP is reopening its doors in just a few days for the first time in more than a year. To find out more information, or to be notified when it does open to the public, just enter your email address in the box below.

Adam J. Wiederman doesn't own shares of the companies above. Apple and Amazon.com are both Motley Fool Stock Advisor recommendations. The Fool's disclosure policy is outlined here.


Read/Post Comments (32) | Recommend This Article (79)

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 October 26, 2009, at 4:33 PM, jmoore7025 wrote:

    Is this a good stock to own at such a cheap price?

    They do have a drug with possible FDA approval next year in April plus are under contract with Novartis

  • Report this Comment On October 26, 2009, at 4:50 PM, jmoore7025 wrote:

    I bought in at 1.14/ share

  • Report this Comment On October 26, 2009, at 6:07 PM, 919dawson wrote:

    Adam Wiederman's article makes many good points and is advice that should be taken to heart by amateurs like myself. One thing he didn't talk about is the tax consequences of taking profits. It's not necessarily a question of additional upside if you think you can defer taxes for another year by waiting, providing that the downside is not that significant.

  • Report this Comment On October 26, 2009, at 6:16 PM, TMFDonauschwaben wrote:

    919dawson,

    Thanks for pointing that out. You're right -- I didn't discuss tax implications. And the reason is twofold:

    1) I think holding a tax merely out of fear of the capital gains tax you will have to pay is not a solid justification for holding it.

    2) Though I used to work as an accountant, I can't dispense specific tax advice. Every investor should make tax decisions on his/her own, or with his own financial planner/accountant, who is familiar with each investor's individual circumstances.

    But thanks again for pointing that out, and I'm glad you enjoyed my article!

    -- Adam

  • Report this Comment On October 26, 2009, at 6:17 PM, TMFDonauschwaben wrote:

    Typo in point 1)... Should read "I think holding a stock merely out of fear of the capital gains tax..."

  • Report this Comment On October 26, 2009, at 7:50 PM, greenwave3 wrote:

    Solid article. Nicely done, Adam.

  • Report this Comment On October 26, 2009, at 8:10 PM, TMFDonauschwaben wrote:

    jmoore7025,

    Unprofitable bio-techs are a little too risky, in my opinion, and I tend to avoid them. I'm a "boring ole value guy," and I'm not quite sure what you mean by a "cheap price." If you mean just ~$1 for an individual share, yea, that's cheap, but if you're referring to the fact that it has an enterprise value (market cap + net debt) of ~$650 million and only brought in $5 million in sales over the past years... I'm not quite sure you could call it "cheap"... but I'm willing to listen if you could prove me wrong.

    greenwave3,

    Thanks for your comment -- glad you enjoyed it.

    -- Adam

  • Report this Comment On October 26, 2009, at 10:49 PM, PeyDaFool wrote:

    "At this point, it would make sense to take your already-high gains on Cell Therapeutics and snap up shares of ConocoPhillips."

    These are two speculative ideas that may or may not become reality. Unfortunately, the market is never this transparent. Also, the transaction costs incurred during these ventures, no doubt, will ad up to a substantial amount of money over time if you decide to sell your winners and buy your speculative undervalued stocks.

    For you (and the sake of your readers), I hope you're right.

  • Report this Comment On October 26, 2009, at 11:02 PM, TDUBFISH313 wrote:

    Since they're big push is the Motley Fool Million Dollar Portfolio, how about let's see some actual results on the whole portfolio. Not just one or two that hit it big. Let's see the whole thing.

  • Report this Comment On October 27, 2009, at 12:02 AM, kstoltz wrote:

    Ooooh, ouch....no no no.

    I can't agree with you that tax considerations aren't a good justification for holding a stock.

    For someone in one of the higher tax brackets, the difference between say 35% and 15% is nothing to dismiss out of hand.

  • Report this Comment On October 27, 2009, at 8:13 AM, TMFDonauschwaben wrote:

    PeyDaFool,

    You said, "the transaction costs incurred during these ventures, no doubt, will ad up to a substantial amount of money over time."

    Not quite sure that makes sense -- most transaction fees are around ~$10 with the major discount brokerages I'm aware of. Though I guess if you're working one-on-one with a broker who charges a commission that's based on a percentage of the amount being traded, you might be getting worked over. But that just means it's time to find a new brokerage house.

    -- Adam

  • Report this Comment On October 27, 2009, at 8:23 AM, TMFDonauschwaben wrote:

    kstoltz,

    I certainly agree with you that capital gains taxes will eat up some of your returns. That's a given.

    But my point is that if a stock is significantly overvalued, the RISK of continuing to hold an overvalued stock and the RISK of that overvalued stock plummeting to fair value (which alone could easily take 15-35%... or more!... of your returns off the table), doesn't make sense when you're up 200% or more.

    That said, if you think a stock is still undervalued when you're up 200% (there are a few of these my wife and my accounts), then by all means, you should hold it!

    You could also offset these gains by selling some losers. I've never met an investor yet who does have one or two or a handful of stocks whose performance is dragging returns down... selling out of these positions when you're cashing in on 200%+ gains might make a smart move.

    But again, it's important for each person to weigh tax considerations for their unique circumstances, or in conjunction with a tax professional.

    Thanks for your comments!

    -- Adam

  • Report this Comment On October 27, 2009, at 8:24 AM, TMFDonauschwaben wrote:

    typo in fourth paragraph... second sentence should read "I've never met an investor yet who DOESN'T have one or two or a handful..."

  • Report this Comment On October 27, 2009, at 11:08 AM, PeyDaFool wrote:

    "Not quite sure that makes sense -- most transaction fees are around ~$10 with the major discount brokerages I'm aware of."

    This is exactly my point. Unless you have a time machine and can go into the future to predict stock prices, selling and buying ($20 total) every time you have a whim that a stock will go up or go down will add up to a substantial amount of money.

    If your intuition was in fact wrong (which even happens to the Oracle), you not only would have to pay $20 for the transaction fees, but your CTIC could continue to rally another 40% while your COP could fall in price.

    It's possible you have super human stock picking abilities and can obtain the actual value of a stock just by doing some simple analyzing, but for the 99.9% of us out there that cannot accurately predict stock trends, buying and holding would be a more suitable option.

    Just my $0.02.

  • Report this Comment On October 27, 2009, at 11:20 AM, TMFDonauschwaben wrote:

    PeyDaFool,

    I guess that the commissions argument you make could be the case if an investor is just getting started, or investing with small positions. But $10 commissions on $10k, $5k, or even $1k commissions are largely insignificant.

    Secondly, the CTIC / COP argument was purely hypothetical, which is why I preceded that paragraph with "For example."

    And lastly, I'm not advocating against buying and holding. But I do think that, more often than not, selling ridiculously high valued companies when they carry lofty valuations, and putting the profits in undervalued companies is the best way to quickly compound your money.

    Thanks again,

    Adam

  • Report this Comment On October 27, 2009, at 11:39 AM, stck101 wrote:

    So is CTIC a good stock to hold on to rightnow? I have been watching it and I feel with the remission rates that it will get apporved by the FDA but I also wonder why this stock has gone down so much in the last month or two...How long is it going to take to get an FDA approval?

  • Report this Comment On October 27, 2009, at 11:45 AM, TMFDonauschwaben wrote:

    stck101,

    As I said above, the fact that CTIC has an enterprise value (market cap + net debt) of ~$650 million and only brought in $5 million in sales over the past years... I'm not quite sure you could call it "cheap"... but I'm willing to listen if you could prove me wrong.

    -- Adam

  • Report this Comment On October 27, 2009, at 4:02 PM, stck101 wrote:

    I really do not understand what you are saying...I wasn't saying it was "cheap." I was asking if it was a good stock to hold on to and wait for the FDA to approval or deny or is it a stock to let go and cut your loses.

  • Report this Comment On October 27, 2009, at 4:41 PM, TMFDonauschwaben wrote:

    stck101,

    Sorry you didn't understand me. Earlier in the comments, I said I was a value investor. Speculating on an FDA approval, which realistically has 50-50 odds, isn't my sort of game.

    -- Adam

  • Report this Comment On October 29, 2009, at 12:06 AM, Kensdumb wrote:

    One other consideration to sell is if you see another investment that really makes sense. I just sold, last week when the market was up, some of my little stock hoard to finance an excellent buy in a truck working in the oil fields that will net about 1000 per week. That's better than I made in stocks. If all goes right we'll have several trucks in a year.

  • Report this Comment On October 29, 2009, at 9:52 AM, kstoltz wrote:

    Adam -

    I agree that there is a point where the capital gains tax shouldn't be a concern. As you said, if you're up 200% in a stock, quibbling over 15% vs. 35% is simply being piggish.

  • Report this Comment On October 29, 2009, at 1:48 PM, jkaytech3 wrote:

    Great article. Selling a rising stock. Is this a good place to place a stop-loss order?

  • Report this Comment On October 29, 2009, at 2:51 PM, TMFDonauschwaben wrote:

    jkaytech3,

    So you prefer selling a stock at a loss to taking profits on a stock that might be overvalued?

    -- Adam

  • Report this Comment On October 30, 2009, at 1:17 AM, pkluck wrote:

    With capital gains rates going up under our great leader, now might not be a bad time to sell and pay the lower capital gain rates.

  • Report this Comment On October 30, 2009, at 12:35 PM, jettrey wrote:

    On the capital gains issue, I did that with UNH, was up a few thousand dollars and thought about selling but wanted to avoid the capital gains taxes. That was in 2008. Want to guess where I am now on that one?

    So the lesson I learned is: Better to recognize a capital gain and pay some taxes than realize a loss.

  • Report this Comment On October 30, 2009, at 1:34 PM, TMFDonauschwaben wrote:

    jettrey,

    Thanks for sharing your first-hand experience with us. I think most people make similar mistakes and end up in a similar situation, regretting not selling.

    -- Adam

  • Report this Comment On October 30, 2009, at 2:48 PM, jbtheone wrote:

    Intersting article, I have a tendency to think "it was up and it will go back up". Which is another way of saying WOW I made a lot money here...and will continue to do so.

    What I am finding through selling stock and then tracking my acquistions gains against my sold stock gain/loss, is that I am doing better with the new purchase.

    Thanks again for the insight..it is so easy to watch a stock go down and then wonder where all the profit went.

  • Report this Comment On October 30, 2009, at 4:12 PM, salvadorveiga wrote:

    On October 29, 2009, at 2:51 PM, TMFDonauschwaben wrote:

    jkaytech3,

    So you prefer selling a stock at a loss to taking profits on a stock that might be overvalued?

    -- Adam

    -------------------------------------------------

    Ever heard the thing called Cut your losses short and let the profits run?

  • Report this Comment On October 30, 2009, at 4:42 PM, salvadorveiga wrote:

    On October 29, 2009, at 2:51 PM, TMFDonauschwaben wrote:

    jkaytech3,

    So you prefer selling a stock at a loss to taking profits on a stock that might be overvalued?

    -- Adam

    ------------------------------

    Ever heard of cutting losses short and let profits run?

    People who sell at a loss are way more likely to make money than people who don't...

    I sell at a loss 60% of the time, and I'm DAMN profitable. How much is the stellar MDP right now? -30% or even under...

    And these guys are getting 500USD a head to manage...

    Here's some bold prediction: MDP in a matter of 2 years probably will be joined with another service or something... if they keep buying stocks and don't sell I expect them to drop more than 50% again along with the market...

    www.mybullmarket.org

  • Report this Comment On October 31, 2009, at 10:13 AM, RadioFreePG wrote:

    I like the first reason the best. I frequently will hold off selling because I just don't have a better place to put the money at the moment. The worst reason I seem to have is a belief that the stock is so far underwater there is no place to go but up so I sit on it.

    Good article.

    rfPG

  • Report this Comment On November 02, 2009, at 10:39 PM, MROKDEAL wrote:

    MR Adam,

    I like to say thanks for sharing your experience with us :)) .

    I just bought 2 days ago 5000 share of "bac" at $15 & 10,000 share of "c" at $4 , and this step for long term investment , What do you think ...thanks alot

  • Report this Comment On March 18, 2010, at 9:32 AM, cacocraig22 wrote:

    My son, a young investor, (both age and as an investor) recently bought 1500 shares of Tenet Healthcare @ $6.33 on a recommendation of a "friend". He is down about 10% and wants to know if healthcare is a good or bad investment? With all that's happening in this field.

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