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. One challenge is overcoming your attachment to the stock -- everyone loves a winner -- and the dream that it will go up indefinitely. You may love everything about VMware (NYSE: VMW  ) , but at more than 125 times earnings estimates, the valuation says sell anyway.

That said, decisions based just on valuation can mislead you sometimes. Amazon (Nasdaq: AMZN  ) has looked rather expensive for years, but it continues to reward shareholders. If valuation on a leading business is perplexing you, you may consider selling just some of your shares (to lock in profits) or protecting your gains through other means (including options), and then consider other factors that may influence a sell decision.

2. Fundamental change in the underlying business
Companies are always undergoing change -- sometimes for the better, often 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, taking on unproductive debt, or a string of failed new product attempts. Whenever a business undergoes a significant change, you need to put on your thinking cap and reassess.

Palm has underdone organizational changes and management shakeups, lost its early lead in handheld devices, and taken on debt, all in the past handful of years. Not surprisingly, it didn't create shareholder value before it was finally acquired by Hewlett-Packard.

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  ) or PulteGroup (NYSE: PHM  ) before 2007, believing a housing boom would continue, you'd have followed housing news closely and may have seen your thesis falling apart -- forcing a timely sale. Both stocks have made a comeback, so if you own either of these stocks today, it makes sense to stay up-to-speed on the health of the housing market. 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.

For many years, it was becoming apparent Abbott Labs (NYSE: ABT  ) had a better business model than the pure drug companies, including Pfizer (NYSE: PFE  ) . Over the last decade, Abbott has maintained its stock price while Pfizer has fallen 60%. 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. To keep membership manageable, Motley Fool Pro will open for only a few days, the first time members have been able to join since June 2009. You can get more information about Motley Fool Pro and receive a special report on three strategies to help you build your wealth by entering your email in the box below.

This article was originally published on June 18, 2009. It has been updated.

Jeff Fischer is the advisor of Motley Fool Pro, and owns no companies mentioned in this article. Home Depot and Pfizer are Motley Fool Inside Value picks. VMware is a Motley Fool Rule Breakers recommendation. Amazon.com is a Motley Fool Stock Advisor pick. Motley Fool Alpha owns shares of Abbott Laboratories. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On December 23, 2010, at 9:51 PM, dimwitbme wrote:

    I posted this several days ago and got no response. Since this post I see that EMC bought about $11million more. That is on top of a recent $7 million and before that over $2 million purchase.

    Original post:

    "l bought this stock based on an off-handed reference in a Fool article about a year ago. It has turned out to be one of my best performing stocks. Is anyone out there looking at the fact that EMC holds 87% of this company and they (EMC) are still buying up stock every month even when it has a P/E ratio of 125? I am asking for someone to give me a reason to sell."

    I am thinking about buying more. I am also waiting for someone to tell me why not.

    dimwitbeme

  • Report this Comment On December 24, 2010, at 11:01 AM, rsinj wrote:

    Maybe because every single insider is selling the stock?

    EMC is the only one buying and in essence supporting the stock price all on its own. You only need to look to history and what happened with Sumner Redstone when he did the same with MWY.

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