So much of our time as investors is spent figuring out how and when to buy companies that we rarely consider the other end of the investment's life: when to sell. But selling is a key part of any investment. In fact, none of us would have ever bought our first share of stock were it not for someone on the other end of the deal (the person doing the selling).
As value investors, we at Motley Fool Inside Value believe that the stock market is not always rational. Occasionally, it spits out unbelievable bargains, like industrial air giant Praxair (NYSE:PX), which in late 2000 was trading as low as a split-adjusted $16.10. It was almost as if the market feared that air was going out of style. Having nearly tripled since then along with annually increasing its dividend, Praxair has been a fabulous company to own.
So now what?
After a company goes on a tremendous rise like that, it's only natural that the first question that comes to your mind might be, "Should I sell?" After all, about the same time that Praxair had bottomed out, microprocessor powerhouse Intel (NASDAQ:INTC) had peaked around $75.60, or practically triple its current price. Perfectly rational investors, having lived through the high-tech meltdown, might just take a look at their tremendous returns with Praxair and decide to sell, based on nothing more than the old market adage, "You'll never go broke taking a profit."
While that may be true, it's also true that every move you make in the market will cost you. It'll cost you commissions and SEC fees. It'll cost you taxes on your profits. You may never go broke taking a profit, but your broker and the tax collector are of course always happy to take large chunks of your profits.
The whole picture
To make a sound decision to sell, you need to keep a broad perspective in mind. Some things to think about include:
- What is the current stock price?
- What is the company's true worth?
- If you sold today, how much would you keep?
- Do you have a better use for your money?
- Is that "better use" superior enough to make up for the difference between how much money you have now and what you'll have left after selling?
By keeping those factors in mind, we as value investors can help protect and assure ourselves that a decision to sell is the right decision to make, even if the company's stock continues to rise after we sell it. None of us can ever perfectly time the high or the low in a stock; I doubt that even the most fervent technical analysts claim that ability. The best any of us can do is make sane decisions, based on what we know to be true at the time, and accept that the market will continue to do what it chooses, especially in the short term.
The real deal
Of course, even if you accept that sell decisions are not to be taken lightly, there are often very good reasons to sell. For instance, Inside Value lead analyst Philip Durell recommended that subscribers sell their MCI shares after the telecommunications company agreed to be taken over by Verizon Communications. A value had been set for MCI shares, after all, by Verizon's purchase pact.
In this instance, a surprise rival bid from Qwest caused a bidding war that eventually boosted MCI's price. In hindsight, it may have been better for shareholders to hold on to their MCI until the dust settled. At the time, however, and given what was known to the public after Verizon's bid was announced, the sell decision was thoroughly justified.
Common pitfalls
As can be seen from the unexpected bidding war for MCI, choosing to sell is not without risks. Probably the biggest risk investors face is focusing on price and price movements alone.
Pitfall 1: Ignoring the worth of the firm when looking at its current price.
Consider McDonald's (NYSE:MCD). In early 2003, the famous burger joint could be picked up for a song -- well less than half its current price. As the company's business recovered, its stock price did, too. Those who bought in near the lows, trusting the company to turn itself around, have been extremely well rewarded. Yet at a recent price of around $29, the company's shares still trade for less than 15 times earnings and sport a decent dividend yield of nearly 2%. Selling now would be like trading in a worn-out U.S. dollar bill that you found on the road for four shiny new Canadian quarters. Yes, you didn't pay $1 to get that dollar bill in the first place. But still, someone is losing money on the exchange rate, and it sure isn't the other guy.
Warren Buffett, of Berkshire Hathaway fame, arguably should have pared his major stakes in Coca-Cola (NYSE:KO) and Gillette (NYSE:G) six or seven years ago, when their stocks traded for more than they were worth. Neither stock has since achieved the levels seen then. (Coca-Cola is an Inside Value pick.)
Pitfall 2: Ignoring the total costs of selling when figuring out how much you'll keep.
Right now, I admit, I'm in an enviable position with Talx (NASDAQ:TALX), the employment and income verifier. The company's stock has nearly doubled in the few months I've owned it. I bought the company at a discount to what I felt it was truly worth, but now its stock has surpassed my value estimate, having run much faster than the growth of the business. However, I'm continuing to hold on to it, because while I may not be able to justify the company's current price, I can justify a value in line with what I'd keep after paying off my broker, the SEC, the IRS, and the state. Should the company continue its meteoric ascent, however, it could get to a point where I will have sufficient justification to actually sell.
In summary
As an investor, you will find yourself wanting to sell your holdings at times. By keeping your head about you and focusing on what the company is truly worth in relation to what you'll keep, you can make rational decisions about holding or folding your shares.
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Fool contributor and Inside Value team memberChuck Saletta owns shares of Talx. The Fool is investors writing for investors.
