When Greed Is Good

"A bird in the hand is worth two in the bush."

I'm sure you've heard this saying before. The lesson it imparts is that it's better to settle for what you have than risk everything in an attempt to gain more. That may work in some situations, but not if you're investing for big long-term gains. To hit on the next multibagger, you need to:

1. Find a great stock.
2. Give it time to fulfill its potential.

The first part is hard enough, but the second may be harder. When a stock appreciates by 50% to 100%, it's tempting to sell and lock in gains. In fact, there are plenty of investors who, after a stock doubles, sell half so they can say they're now playing with "house money." Unfortunately, both approaches can lead to huge losses. Yes, losses.

Learn from the worst
Take my biggest loss, for example. In January 2005, I had been doing some research on SanDisk and realized that a dominant name in an emerging industry -- in this case, flash memory -- was undervalued relative to its peer group. Even better, I calculated it to be a $60 stock. So I picked up some shares at $24.75.

But over the next few months, the stock just sat there. Sat there! Had my research been wrong? Finally, SanDisk jumped to $32.25 after a good second-quarter earnings report, and I decided to pocket my 30% return before the stock returned to the $20s.

That's been the most painful 30% gain of my life. By early January 2006, SanDisk surged to a high of $79.80, and I had to swallow a 190-percentage-point opportunity loss.

Learn from the best
Fool co-founders David and Tom Gardner and their team at Motley Fool Stock Advisor are loath to sell great stocks -- although they have done so and later regretted it.

One of those lessons came from Tom's selection of Daktronics (NASDAQ:DAKT) in 2003. Eighteen months later, the stock had gained 12.6% for the portfolio, and Tom, concerned about shrinking margins and growth rates, decided to capture the gain and sell the position. The stock continued to grow, however, gaining an additional 77%

The Daktronics lesson paid off a few months later, when Tom decided to hold on to Healthways (NASDAQ:HWAY) -- even after it had returned 25% in a year's time. He sensed that there was still a wide market opportunity for innovative health care-enhancement services. And that was smart. The stock has now returned more than 50% since it was first recommended.

A stock that had a good year can always have another one. Indeed, cutting winners short is one way that many individual investors hurt their returns. Sensing that energy prices were peaking in the summer of 2005, many investors believed that the run in the sector was nearing an end. Yet those who bailed on these international oil plays missed out on even better returns.

The Foolish final word
If you believe a stock has run its course and is overvalued, then by all means sell and take your gains. But if you truly believe in your original assessment of a stock, then let your winners run. While there will always be a few bad picks in your portfolio, your winners can more than make up for them if you hold onto them patiently.

Need help picking some winners that are worth keeping around? Give our Stock Advisor newsletter a go-round for 30 days, free of charge. Tom and David thoroughly explain all of their picks as well as the drivers that make them worth holding for the long run.

This article was originally published on Aug. 2, 2006. It has been updated.

Todd Wenning does not own any shares of companies mentioned in this article. Healthways is a Stock Advisor pick. The Motley Fool has adisclosure policythat even Chuck Norris couldn't get out of with a roundhouse kick.