Most loyal Fool readers know how we feel about selling. If you've found a great company with top-notch management and a strong competitive advantage, the best time to sell is almost never.
But that doesn't mean we hold on blindly. Things change, even with the greatest of companies. That's why we're constantly evaluating our stocks and watching for the danger signs that can torpedo our portfolios.
Today, I'd like to share three rules for selling, as set forth by Fool co-founder Tom Gardner for his Motley Fool Stock Advisor members.
1. Selfish management
Tom calls this the "worst possible development" for any of his companies. If the executive team starts worrying more about lining its own pockets than about creating value for the business, it's time to let go. For clues, keep an eye on excessive compensation, aggressive accounting, active insider selling, and declining market share. A classic example occurred at Fannie Mae
2. Competitive disadvantages
Competitive advantages are what lead businesses to high returns on capital and equity. These advantages could be a result of many things -- for instance, Disney
3. An unstable financial model
Let's consider stable models first. Think of Logitech
What about valuation?
Obviously, a stock carrying a sky-high valuation is a candidate for selling. But this is the toughest call of all. If properly valuing a company were so easy, after all, everyone would be rich ... happily buying low and selling high. In One Up on Wall Street, Peter Lynch recounts agonizing when to sell as Warner Communications, now a subsidiary of Time Warner
But the three sell signs above aren't too hard to spot. Tom and his brother, David, have employed accurate selling and buying guidelines on their way to outstanding performance in Stock Advisor -- 71% total average returns versus 28% for equal amounts invested in the S&P 500. You can get a look at their two new picks -- plus all their top five stocks for new money now -- free of charge with a 30-day trial. There's no obligation to subscribe.
This article was originally published April 12, 2006. It has been updated.
Time Warner, Disney, and Bed Bath & Beyond are all Stock Advisor recommendations.Fannie Mae is an Inside Value pick.