After struggling through the last several months of stock market carnage, I must admit I have been tempted to take some profits. A brief conversation with TMF Gibson over valuation issues and when, if ever, there is a time to take profits and run, and I caught myself feeling guilty.

Guilty for talking about or even thinking about selling. Fools preach a good deal about buying and holding but we rarely address when to sell. So I did a little searching through our archives to re-acquaint myself with Foolish thinking about selling and applied the logic to my recent Sun Microsystems (Nasdaq: SUNW) sell/hold decision. My thoughts are in italics.

I hope this provides a guide for those of you new to the Rule Maker and can serve as a refresher course for the veteran readers. Not all of the following articles are Rule Maker writings, but they all lend direction when contemplating that fateful decision to sell.

The original foundation of our selling philosophy is not entirely of Rule Maker descent or even Motley Fool lineage. Rather, it is based on the writings of Philip Fisher. In his 1958 classic, Common Stocks, Uncommon Profits, Fisher makes it perfectly clear that selling is not a big part of his strategy by devoting "exactly eight pages to the subject," as Bill Mann points out in this Fool on the Hill article. Fisher's reasons to sell are:

  1. When it becomes clear that the original rationale for purchasing was flawed.
  2. When a company no longer qualifies as a top performer.
  3. When there is a better place to put your money.

I bought Sun in February 1999 at a cost of $16.50 per share. When it hit $33 by November, I re-evaluated based on my original target of 2x5y. Basically, 2x5y means I want to invest in companies that can increase market value twofold (100%) in five years. For more on 2x5y see this article. My rationale for purchasing was still on par, Sun's industry position was strong, if not stronger than before, and I did not have any other brilliant investment ideas at the time. Movin' on...

As with most rules, there are always exceptions and Fisher provides an out by stating that it is always time to sell when you are "making a choice of happy living." As I read it, if it's time to stop investing and time to start spending (i.e., retirement), knock yourself out and live a little. Enjoy the rewards of your many years of disciplined investing.

I' m not quite ready for retirement, although my golf game is suffering from this menacing work thing. I am thinking of purchasing a new house. Maybe I should take some profits and put it into my down payment. Hmm? Nope, I think Sun will provide better returns over the next decade or so than the appreciation on a new home. Next up...

Fools Phil Weiss and Matt Richey expanded on Fisher's rules and came up with five reasons for selling based on company fundamentals and portfolio management. The company fundamental-based rules are:

  1. Crooked management.
  2. Deteriorating financials.
  3. Mergers, acquisitions and spin-offs.

The portfolio management based rules are:

  1. A much better place to invest your money.
  2. Time to rebalance your portfolio.

Scott McNealy, Sun Microsystems' CEO, is a little obsessed with destroying Bill Gates and Microsoft (Nasdaq: MSFT). What's up with that Javaman suit anyway? Nah, Scott's not crazy, he's a good manager. EPS growth of 60% doesn't look like deteriorating financials, and I doubt any company is gonna make a $100 billion bid for Sun. I can't think of a many companies with better long-term prospects, but maybe I should pare down my Sun holdings. It is nearly 40% of my portfolio. I would love to buy some more Charles Schwab (NYSE: SCH) and Oracle (Nasdaq: ORCL). [Scratches head and thinks.] Let's do it. I know Bill Mann will be disappointed, but maybe he won't send me through the Fool Spanking Machine this time. Sell 25% of holdings and re-allocate to other promising holdings. Still a Fool!

Lovable, fearless Bill Mann enlightened us even further when he questioned our Foolishness if we should waver and sell for any of the bad reasons (often used by professional money managers) listed below:

  1. Your portfolio is overweighted in one or two companies.
  2. A company you own has become "overpriced."
  3. There is a potential market downturn.
  4. The stock has just had a huge run-up.

He also challenged the theory of selling to rebalance your portfolio, knowing he would receive the full support of David Gardner based on his March 1999 Rule Breaker article. David tells us to "let your winners run" and also points out that selling off portions of these winners to buy other opportunities is OK. It also comes down to risk tolerance. Keep in mind that these rules are not intended to be applied across all your holdings. They are intended for the expressed written consent of individual portfolios.

Uh, oh. Now I've done it. I definitely broke Rules 1 and 4. Looks like I can't avoid the spanking machine this time. I hope he doesn't tell David, I can't afford to lose two jobs in 18 months. What's this? I can sell part of my holdings to reinvest in other promising opportunities. Phew. Feeling more Foolish than ever!

Some of the underlying principles behind a buy-and-hold strategy are simple. Less selling means less transaction costs, which helps long-term performance. Taxes take a bit out of gains. There is no way around that. And perhaps the most important reason of all, selling takes away from future gains. If you sell it, you're out. End of story. After you spent all that time researching your investment, why get out unless you plan to never return. In that case, you are probably getting out for one of the reasons listed above.

Hope this helps.

Fool on.