A reader wrote to me to ask this question: "I bought what I thought were fairly valued shares of a company at $30 each, planning to hang on for five to 10 years. But, in less than a year, the stock shot up to $90 -- a three-fold rise. Should I hang on or sell?" If you've been fortunate enough to invest in some of the past decade's best-performing stocks, including Hansen Natural (NASDAQ:HANS), Chico's FAS (NYSE:CHS), and Yahoo! (NASDAQ:YHOO), you've probably pondered such a question.
Here's how you might think about the problem (or lucky dilemma, depending on how you view it). How quickly were you expecting this stock to grow over the long haul? If your research and assumptions suggested 10% annual growth, you'd expect the $30 stock to hit about $48 in five years and roughly $78 in 10 years. If you really don't plan to hold on to the stock any longer than five or 10 years, you might want to sell, as you've already gotten all the growth you expected from the shares.
However, perhaps you're thinking of holding for 15 years. If so, growing at 10% from the $30 you considered its approximate fair value when you bought it, the stock might reach $125 (and in 20 years it would hit $202). In this case, you might consider hanging on. Selling will cost you a capital gains tax (unless you can offset your gains with losses). Also, the short-term capital gains tax rate, for securities held a year or less, is your ordinary income tax rate -- which could be as high as 35%. At the very least, consider hanging on until a year and a day has passed. Then you'll probably just be paying the long-term capital gains rate of 15% for most folks.
Here's another important angle to consider, though. If the stock is at $90 now and you expect that its fair value will be about $125 in 15 years, then from this point on, you're really just counting on an average annual growth rate of 2.2% over that period. You can do much better than that just in a safe CD, not to mention a host of other stocks.
If you're more concerned about getting yourself into this position, take a free look at our investing newsletters. With their track records of impressive performance, you might find yourself with a three-bagger in no time.
Longtime Fool contributor Selena Maranjian owns shares of Chico's. Yahoo! is a Stock Advisor pick. The Fool has a disclosure policy.
