Warren Buffett has explained that anyone with an average level of intelligence can be a successful investor if they have the temperament for it. He is, of course, alluding to the fact that emotions are likely to be a much bigger part of the investment equation than anything else. Which is why I find selling a stock so hard -- and why you might too. But it's not actually a bad thing.
Humans hate to lose money
There's two ways to look at selling a stock. One is that you have a dog on your hands, and by selling you will lose money. The other is that you have a winner and you could make money, but you might miss out on more gains. Either way, the fear is that you will lose in some way by selling a stock. I have to be humble here -- these are natural human emotions, because humans really hate losing.
Image source: Getty Images.
The problem is that the emotional distaste for losing money can lead to bad investment decisions. That can range from telling yourself something like, "I'll sell it when I'm back to break even." Or, maybe worse, you might just ignore the stock and pretend it isn't there so you don't have to confront the issue at all. I'll admit it, I've done both. But I'm always trying to do better.
That's why I now write down my reasons for buying a stock. This is vital, because it gives me something to gauge the investment by in the future. For example, when I bought 3M (MMM 0.46%), I believed the highly diversified industrial company would muddle through a weak patch for its business and be able to withstand the legal headwinds it was facing. As time went by, it became clear to me that I could track the company's success on the business front, but there was no way for me to monitor the legal issues. The company couldn't talk about them, so when something happened, it was a complete surprise.
Then management made plans to spin off its healthcare division. I had expected healthcare to be an important growth engine for 3M over the long term, so in my view a spin off would materially alter the company's future prospects. Yes, the move would protect the healthcare division from the legal costs the company was facing, so it wasn't a bad choice business wise. But I was left with a company that I couldn't track as well as I would like, and one where I believed the future direction of the business was about to drastically shift. I chose to capture the losses I was carrying so I could make some broader portfolio shifts. I still think 3M is an attractive long-term business, but it's just not living up to my original thesis. (I still own a very small position because I want to force myself to continue tracking the turnaround.)
That loss hurt, but I had to take it if I wanted to sleep well at night. Luckily I had ways to use the losses so the sting wasn't quite as bad as it might have been.
Selling isn't always the answer
That said, I don't always sell a loser. There are times when holding, or even adding more, can make a great deal of sense. For example, I owned a company called American Realty Capital Properties. I got sucked in by a high yield -- but just shortly after I bought it, the company announced an accounting problem. The stock plunged, but the accounting issue was relatively minor. I decided to see what happened next.
To its credit, the board of directors acted decisively. It cleaned out the top brass and brought in a well known industry turnaround expert, Glenn Rufrano, who brought in a new team and set out very clear goals. He basically hit every single one of them. I know because I tracked the company's progress. And then he sold the company, which had been renamed VEREIT, to Realty Income (O -0.17%). Along the way, I collected some legal settlements from class action lawsuits against American Realty Capital Properties. All in, it has been a net win of an investment, with a little excitement at the beginning of my holding period. I'm glad I stuck around, but I had to do some real soul searching about what was happening at the company during the difficult times it faced.
My original logic was basically to collect an attractive yield from a diversified net-lease real estate investment trust (REIT). Because of the turn of events it became a turnaround story being led by a well respected industry leader. Now that the turnaround is complete, my reason for owning Realty Income is back to collecting an attractive yield from a diversified net-lease REIT. But now the REIT is the largest competitor in the net-lease market.
I'm faced with a similar level of consternation with consumer staples giant Hormel (HRL 0.14%). I bought the company because it has a portfolio of well-loved brands, a strong history of innovation, and a swiftly growing dividend. Right now the food maker is facing a number of headwinds, including avian flu, a recent acquisition that's taking a bit longer to turn around than hoped, weakness in China, and pushback from consumers amid recent price increases.
I expect all of those problems to be temporary. Basically, the company, despite poor stock performance, continues to live up to my original thesis. I have added more to the stock multiple times. Notably, the most recent dividend increase was 6%, which is pretty attractive given the list of headwinds management is dealing with.
But I chose to sell Kellogg (K -1.23%) after the company announced plans to spin off its North American cereal business as a separate company. I probably didn't act quickly enough, choosing to spend some time to really think through my concerns. My original expectation was that Kellogg would use a strong core business to expand into more growth-oriented areas. That included the cash cow cereal operation in North America. The spin off will likely mean the new Kellogg, to be known as Kellanova, grows more quickly in the future -- but it creates odd entanglements, like Kellanova selling Kellogg cereal outside of North America. Then there's the Rice Crispy Treats business, which it will still control in North America even though it is tied directly to a brand that will be owned by the divested North American cereal operation.
The story has changed too dramatically and in a way that feels forced. I don't want the "bad company" (the North American cereal business), which is highly likely to be shunned by investors. I had some profits and took them to avoid ending up with an investment that no longer lived up to my original expectations and one that I didn't want to own as a stand-alone company. I also expect that there could be a dividend cut that goes along with the transaction, which would materially reduce the attractiveness of the investment within my income-focused portfolio.
Think before you act
There are no easy answers when it comes to investing, and sometimes I don't even follow my own rules to the letter. One major problem that I face, and many others do too, is selling. I think the best course of action is being willing to change as the situation changes, using your purchase logic as a base point for comparisons. Sometimes that will make the choice to sell an easy one, other times it will result in you holding firm or even buying more. But the hard work is actually sitting down and working through the investment, no matter how difficult it may be to admit that you made a mistake.
