When Greed Is Good

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

This familiar maxim teaches us that it's better to settle for what we 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 even harder. When a stock appreciates by 50% to 100%, it's tempting to sell and lock in gains. In fact, plenty of investors sell half of their holdings after a stock doubles, 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 I realized that this dominant name in the emerging flash memory industry was undervalued relative to its peer group. Even better, I calculated its real worth at $60. 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 -- though it's since been trending back down. Still, I would have done better had I held.

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've both done so, and later regretted it.

One of those lessons came from Tom's selection of Whole Foods Market in 2002. A year later, the stock had gained 72% for the portfolio, and Tom, believing it now sat on a tenuous valuation, captured the gain and sold the position. The stock continued to grow, however, gaining an additional 55% after it was sold (David has since re-recommended Whole Foods to Stock Advisor subscribers).

The Whole Foods lesson paid off a few months later, when Tom decided to hold onto Quality Systems, even after it had returned 154% in a year's time. He sensed that there was still a wide market opportunity for digital medical records. That was a smart move. The stock has now returned more than 600% since it was first recommended.

A stock that had a good year can always have another one. Indeed, cutting winners short hurts many individual investors' returns. Sensing that energy prices were peaking in summer 2005, many investors believed that the run in the sector was nearing an end. Yet in some cases, those who bailed on these oil plays missed 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 owns shares of Core Labs. The Motley Fool has a disclosure policy that even Chuck Norris couldn't get out of with a roundhouse kick.