Ask a Fool: When Do You Know to Sell a Stock?

When do you know it's time to sell?

It's a decision that investors have struggled with as long as there have been markets, and one that has a lot of right and wrong answers. 

We asked five of our contributors to give us an example of when they would sell, and here's what they had to say. 

Selena Maranjian: An excellent reason to sell a stock is if you can't explain why you own it. Perhaps you bought your shares after reading a short but breathless article about the company, and now you can't even recall exactly what the company does. Perhaps you bought it for some good reason years ago, but you no longer know what the reason was and if it's still valid. After all, companies do change over time, and they can get more or less promising, as competitors and new technologies emerge.Maybe you inherited the shares from a generous loved one, but you know little about the company and its prospects.

These are all situations where you have little business owning the stock -- in part because it could plunge one day and you won't see it coming.

It's a valuable exercise to jot down at least a few paragraphs about each of your stock holdings, explaining why you own the stock, and when you would sell. Revisit these pages regularly as you keep up with your holdings, to make sure that the companies are still executing their strategies well and remain among your best investment ideas.

Always aim to have your money invested in your best, most promising ideas. After all, why put money into your 37th-best idea when you could just add more to one of your top five ideas that's attractively valued? If you have no idea how promising your various holdings are, you need to do more research -- or simply sell the stocks and move the proceeds into an inexpensive broad-market index fund, such as the SPDR S&P 500 ETF, Vanguard Total Stock Market ETF, and Vanguard Total World Stock ETF. Those are the kinds of investments you can keep for decades without thinking too much about them.

Jordan Wathen: I tend to think that it's true that even the greatest businesses in the world are great for only one reason. If you look at Costco, perhaps one of the best retailers on Earth, it's great because it sells its inventory faster than just about anyone else and manages to keep a majority of its members paying dues each year. Visa is an incredible business because, over time, inflation leads to more spending, and more spending is moving to cards, which drives its profit growth. Berkshire Hathaway is an incredible company in part because its insurance companies do what few can't -- charge enough in premiums to cover losses and expenses.

The best time to sell a stock is when a company's most fundamental driver breaks down. For RadioShack, that might have been when the company had to change strategies and focus more on phones than on obscure electronic parts and batteries. For Lumber Liquidators, it may just be that price is no longer the most important factor guiding the purchase decision; quality is. 

Every time I buy a stock, I make a list of a handful of factors that underlie my rationale for buying it. It keeps these things at the top of my mind, and if anything ever changes, I know it's time to part ways.

Sean Williams: There are a veritable sea of reasons investors jettison a stock, but none stands out as more valid to me than when the underlying fundamentals of a business change.

Throughout your investing years, you may have heard that you should seek out "broken stocks, not broken business models." A broken stock is merely a company that's hit a few bumps in the road, but that still has a valid business model over the long run. In other words, there are clear growth drivers that a company's management and investors can still foresee. In the case of a broken business model, the previously believed growth drivers are no longer in play, and the long-term success of a stock or industry cannot be guaranteed.

Two years ago I had to make the painful decision to part ways with my investment in Tower Group, a property and casualty insurer on the East Coast, because the fundamentals of the business had changed. Under normal circumstances, insurers possess incredible pricing power and can boost premiums to cover higher claims costs. However, in Tower's case, a restatement of its financials led to a $365 million loan loss reserve shortfall. Not only would Tower have to raise this cash (diluting investors in the process), but the resulting credit downgrades that ensued also pretty much wiped out its ability to underwrite new business. The model was broken.

As you decide whether to sell a stock, take a close look at the underlying business fundamentals and determine whether you're dealing with a potentially broken stock, or a broken business model.

Joe Tenebruso:  Every investment has an opportunity cost. That's because we all have a limited amount of capital, and every dollar we invest in one company is a dollar we can't invest in another. So the best way to reach our financial goals within our desired time period is to always try to optimize our investment returns. Therefore, the reason I sell a stock is most often that I've simply found a better investment option.

What makes a stock a more attractive investment than one I already own? Well, admittedly, the process I use to answer this question is more art than science. However, I also think that this is where my edge lies -- in looking past the numbers and emphasizing the intangible aspects of business.

Most often it's that I believe the new company has stronger competitive advantages. That could be a more valuable brand, better business model, superior products or services, or more competent management. Even better is when the new company is in the process of widening its competitive moat. In essence, I always want to own the businesses that are the strongest and growing stronger, as I believe that is the best way to generate superior risk-adjusted returns.

Jason Hall: The very best reason to sell a stock? You've finally reached an investing milestone, and it's time to cash in some of those hard-earned gains and pay for a child's education, start funding your retirement, or get that vacation home or RV you've been wanting for years.

I think that keeping this in mind before you sell any stock can help you make better investing decisions, because it can help keep you focus on your goals, and not on the short-term distractions that can lead to bad choices.

If you keep your eye on your goals, versus getting caught up in the short-term of the market, you'll probably make better decisions about when to sell.