We were asked, "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?"
What a lucky dilemma! Here's how you might think about the problem. 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, since you're not expecting much more growth.
However, perhaps you're thinking of holding on 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 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). And, 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 40%. At the very least, consider hanging on until a year and a day has passed. Then you'll just be paying the long-term rate of 20% for most folks, less if you're in the 15% tax bracket.
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.
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