In the theme of Christmas and the spirit of giving, I plan to use the next two weeks leading up to Christmas to count down the 12 Days of Christmas in all its Foolish glory. In my rendition of this Christmas tale, you won't be hearing about turtle doves or French hens, but you'll probably hear about great ways to save money in 2013 or about CEOs who laid rotten eggs in 2012.
In the previous "Foolish Days of Christmas" we've looked at:
As always, I ask you to sing along with me: "On the eighth day of Christmas my true love gave to me ..."
Eight possible reasons to sell a stock!
I've received dozens of emails and comments in my two-plus years with The Motley Fool regarding how I know when it's time to sell a stock. Here are eight reasons I can think of why someone might sell a stock, although I still stand by the Motley Fool ethos that long-term buy-and-hold is your best path to a comfortable retirement.
Valuation is the most common reason people sell a stock, according to my Foolish colleague Jeff Fischer, but it's also the most difficult reason to explain, since no two stocks are alike, and there aren't any set rules that say "sell if stock XYZ hits this level." Each sell candidate should be looked at on an individual basis and compared relative to its peers, not just the market in general. Using US Bancorp (NYSE: USB ) as an example -- it trades at just 10 times forward earnings, well below the average P/E of the S&P 500, but it's valued at 175% of book value, a huge premium in the banking sector relative to its peers.
2. Fundamental change in the business
Fortunately, this one's considerably more cut-and-dried relative to selling based on valuation. Specifically, if a business model has been put in jeopardy by a poor or adverse decision or series of decisions, then it's unlikely that your investment thesis is still valid. A perfect example is Diamond Foods (NASDAQ: DMND ) , whose world came crashing down when it was investigated and found guilty of improperly paying its walnut growers earlier this year. This scandal completely debunked all positive reasons to own Diamond Foods and has effectively put yellow caution tape around the stock.
3. Change of faith in management
You could make an argument that this category could be lumped under a fundamental change in the business, but I firmly believe that investor confidence in management is an important aspect to any long-term investment. If that confidence is lost, your investment thesis for owning a stock in question is likely to be broken as well. Hewlett-Packard (NYSE: HPQ ) offers perhaps the most stark example. Through a series of gaffes within the past two years, HP has had three separate CEOs at its helm, and none has particularly inspired confidence in a once proud hardware company.
4. Fundamental macroeconomic change
Sometimes you sell because the business model you purchased is no longer valid (e.g., Diamond Foods), but sometimes the business model for an entire sector can go bad. A case in point would be the homebuilding sector, which has taken the better part of six years to find a bottom. Hindsight would have told you to sell Lennar (NYSE: LEN ) in 2005, but it wasn't until 2007 that we began to see that Lennar and the entire housing sector was in major trouble because of a mountain of bad mortgages. These fundamental macroeconomic shifts aren't easy to identify, but once visible, they can offer people the motivation to sell.
5. Tax reasons
As we're probably all too aware with higher taxes on the horizon in just two weeks if Congress doesn't get a fiscal cliff deal done, tax-related selling is another somewhat common reason to sell a stock. At the moment, it pays to hold onto your stocks for the long term, because the short-term capital gains tax of 33% is awfully painful relative to the 15% long-term capital gains tax. However, sometimes selling a stock at a loss lowers your annual stock gains or reduces your annual income to the point where you fall into a lower tax bracket.
6. Your values change
Consider this the socially responsible aspect of the sell-side theory. Certain investors choose not to own vice stocks (companies that produce tobacco, firearms, alcohol, and the like) from the day they begin investing. For others, their investing values change somewhere in the middle. I can relate to this from a personal perspective: Before losing my mother to lung cancer two years ago, I would have been a prime supporter of Altria (NYSE: MO ) and other tobacco companies. However, since that incident, I can't see myself buying into the sector anytime soon, if ever, regardless of Altria's pristine dividend and highly addicted following.
7. You see better opportunities elsewhere
Selling a stock for what is perceived to be a better opportunity has a very broad meaning. Sometimes that opportunity could be buying a house or starting your own business, whereas other times it may just be swapping one stock for another because the potential for long-term appreciation appears markedly higher.
8. An emergency
It's no secret that Americans are terrible savers. Recent data from the Employee Benefit Research Institute notes that 56% of workers have $25,000 or less in savings. Furthermore, 29% of workers have less than $1,000. With savings figures like these, I wouldn't be surprised if someone sold stock if an immediate need for cash arose because of an emergency.
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