A reader asked us: "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 threefold rise. Should I hang on or sell?"
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 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're not expecting much more growth.
However, perhaps you're thinking of holding for 15 years. If so, growing at 10% from the $30 you consider its approximate fair value, the stock might reach $125 (and in 20 years, it could hit $202). In this case, you might consider hanging on. Selling will result in a capital gains tax (unless you can offset your gains with losses). In addition, 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 for a year and a day. Then you'll probably just be paying the long-term rate of 15%.
Here's another important angle to consider. 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 expecting an average annual growth rate of 2.2%. You can do much better than that in a safe CD, not to mention a host of other stocks.
These are just a few of the kinds of things to consider when evaluating your holdings and making buy/sell decisions. You can learn more about how to evaluate companies in our Fool's School.
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