Last week, I tackled the critical investing question of when to buy into a stock. As promised, I'm addressing the other critical question -- when to sell. Permit me to begin with a quotation from Robert Frost: "Take care to sell your horse before he dies. The art of life is passing losses on."
This philosophy might seem callous, but it's not inaccurate when it comes to investing. If you know you've got a stinker of a stock on your hands, the right thing to do is to sell it, no? Well, when you sell it, you're not putting it out of circulation -- you're handing it over to someone who wants to buy it. The art of investing, at least to some degree, does seem to be about passing losses on. (Of course, the more skilled you are at investing, the fewer losses you should have.)
Beginning investors might think that if they become good enough at investing, they won't have to worry about selling, and they won't have any stinkers on their hands. It's good to keep solid performers for many years -- that's how many people become wealthy -- but you should never think that you're safe from errors. Even the best investors still make mistakes, though they don't repeat them too often. I'm not one of the best investors, and I've made many blunders (try to avoid mine).
So as you invest, expect some mistakes. Expect some losses. It happens to the best of us. But if you learn when to sell, you can reduce your losses.
Sell on ignorance
One of the best times to sell is when you don't know enough about a company. Ignorance can take many forms. In some cases, you may not remember why you ever bought a stock. In other situations, you may know very little about a company you're invested in. Perhaps you bought only because of a rave recommendation you read somewhere, or you inherited shares from Uncle Chester, or maybe you just thought the ticker symbol was cute. (Check out the symbols for Southwest Airlines
Here's a simple test: Can you talk for a whole minute or write a full page about a company you own? It may sound easy, but it's not. If you can't do that, you may not know enough about it. Do you know how it stacks up against competitors? Do you really know how it makes its money (or what its business model is)? Sure, you may know that it makes and sells escalator parts, but how does it do so? Does it have stores, which can be expensive to maintain? Does it do everything over the Internet in an automated and cost-effective fashion? Barnes & Noble
If you can't find the company information you need, or you feel the firm is hiding something, then seriously consider selling. Perhaps a company has a compelling business model, but you just don't see evidence of many sales yet. Remember that the Betamax video technology was in many ways better than the VHS alternative, but VHS won out. Similarly, many think that Apple
More reasons to sell
If the company can't hold up under scrutiny, then it's time to sell:
- The company doesn't interest you, and you don't keep up with its progress. This is critical. If you don't follow the firm, you might miss red flags, and you could end up selling too late.
- The stock has become significantly overvalued relative to what you think it's worth. Consider the tax consequences, though. (If you expect the stock to keep rising in the years ahead, you might do well to just hang on.)
- The company's financials are deteriorating. (It's vital that you read the quarterly and annual reports.) Look for drooping sales and earnings, rising debt, shrinking profit margins, ballooning accounts receivable, and a number of other items. Here are 10 things to look for in an annual report, as well as an investor's guide to conference calls.
- You'll need that money within a few years. Any greenbacks you'll need in three to five (or even 10) years should be in a less volatile place than stocks, such as money market funds. Learn about your options in our Savings Center, which features special rates for Fools.
- You've made as much money on the stock as you wanted and expected. Many investing blunders are tied to greed. If you can't reasonably expect much more growth, then don't blindly hope for it.
- The reason you bought is no longer valid. If you bought shares of eBay for its high-profit margins, and then eBay buys a large supermarket chain, then stop and think. Supermarkets are a different business, with lower margins. You might decide to hang on, but first reevaluate the holding.
- You found a much more attractive place to invest your money. If your calculations suggest that a holding is now fairly valued and another stock appears to be undervalued by 50%, transferring your dollars might make sense. Again, though, consider the tax effects.
- The stock is your only holding. Portfolios should be diversified. We suggest aiming to hold eight to 15 stocks. If one grows to represent more than 33% of your portfolio, consider rebalancing it.
- You're only hanging on for emotional reasons.
There are, of course, more reasons to consider selling a stock. (Shannon Zimmerman recently addressed when to sell a mutual fund.) Share your reasons on our discussion board, or just pop in to see what others are saying.
And if you want to see what stocks (or mutual funds) Fool analysts are recommending for your consideration, look into our suite of investing newsletters. We have several that target different investor interests, and we offer updates on when and why we sell recommended stocks and funds. Try out our newsletters for free, and sign up for our free research reports as well.
Selena Maranjian owns shares of eBay and Amazon.com. For more about Selena, view her bio and profile . Also, check out these books she's co-written: The Motley Fool Money Guide and The Motley Fool Investment Guide for Teens . The Motley Fool is Fools writing for Fools.