One of the most common requests we hear from members is "More sell advice, please!" Whether you're a die-hard buy-and-holder, or someone who prefers to sell more frequently, it can be just as important to know when to sell as when to buy.
Today, we're unveiling a new service, Motley Fool Special Opportunities, managed by returning Fool Tom Jacobs. Tom got his start in investing working alongside David Gardner and Motley Fool Pro advisor Jeff Fischer on the Fool's original real-money Rule Breakers online portfolio. Tom has since become a deep-value investor, focusing on micro caps and special situations. Tom considers himself a strategic seller, while David almost never sells. Where do you fall? Share your worst (or best!) sell story in the comments below!
When is the right time to sell a stock?
Tom Jacobs: When you have a better place for your money -- David and I agree 100% on that. But what does that mean?
For me, it means either that my reason for owning no longer works, or the stock is still fine, but something else is better. The latter happens often in down markets, when panicked sellers leave better and better companies for cheap. I say that I don't sell, actually, but switch. When stocks of businesses I know and can value sell off to bargain prices, I'll switch any day.
So that's for a stock by itself. But stocks don't exist in isolation; they are parts of portfolios. If something I own rises to a huge percentage of my portfolio -- 20% or over -- I don't care how great it is. You never have all the information about any company, and information risk is pretty huge when something is that much of your money. So that's the second time I sell.
David Gardner: That's pretty much the way I think about it, too, with the only difference being that I have had stocks run up to well more than 20% of my portfolio. AOL (NYSE: AOL) was my huge stock in the 1990s -- I won't say how much, but it was more than 20%. I'm not a nervous investor if I feel like I know the situation well. In general, I've been rewarded -- though given how much AOL fell later on, I would have been smart to sell a portion earlier than I did! That said, I think the key insight I bring is that I believe most people sell winners too fast, to the point that they never get to have the "problem" of a huge winner.
What experiences have influenced your sell philosophies the most?
Jacobs: That's easy. When I first joined The Motley Fool, I was fortunate to work with the Rule Breakers online portfolio team -- David, Jeff Fischer, and the whole wonderful gang.
But no matter how hard I worked, I couldn't escape it: I was no David Gardner. Rule Breaking worked for him and for many others, but not for me. You have to find the strategy that works for you.
So during the 2000-02 crash, I returned to the lessons of my parents, who saw the crash of 1929 and struggled through the Great Depression. Starting with Benjamin Graham -- who began his value investing life after almost getting wiped out in 1929 -- and his student Warren Buffett, I found that value investing fit my personality perfectly. It's served me well ever since -- 181% versus the S&P 500's 39% -- since going all value, all the time. That comes with good years and bad years, by the way. You have to stay strong in the bad times and be suspicious in the good ones.
Gardner: There are three experiences that come to mind. The first is how I used to invest in my late teens and early 20s. I generally had a target price in mind -- usually not much more than a double for a stock -- and if I achieved that, I would sell. I learned from that that you won't get very rich if you invest that way. You'll end up trading more, and you don't end up looking for real quality. You will never end up buying Cisco or Dell in the 1990s. You won't buy great companies and hold them for 10 years of great appreciation.
The second experience was AOL, which I bought very, very low and held all the way up. My cost basis was about $0.40, and it went up to around $100, and then I watched it fall down to $35, where I finally sold some, and then I think it dropped to around $8. It was still a 20-bagger in five years, but I had a huge win, and I lost a lot of that. It came back to around $20, and at that point, we sold. I think there's something to learn from that -- if a stock rises a huge amount, you just automatically start to sell off small portions of it. Had I done that, I would have been happier.
The third experience was with Amazon (Nasdaq: AMZN), and I'm really glad I held on to that. In the Rule Breaker portfolio, we bought Amazon at around $3, it went to $95, and then dropped all the way to $7. I can imagine some people concluding that buy-and-hold doesn't work. But I kept holding, and Amazon is now at about $120. So I'm really glad that I took a long-term view. You have to suit your holding mentality to the quality of the company. Amazon is one of those flames that will burn brightly for a long, long time. Not many companies are that way, so I can see why it makes sense to sell them after a few years, but for me, that was the most influential sell experience of all -- that I didn't sell, I just stuck with greatness and didn't give up when it was down.
What metrics or indicators do you key in on when considering a sell?
Jacobs: It's 50% numbers and 50% experience and judgment. When I buy, I come up with a range of what a buyer would pay to own the business -- the net present value of future cash flows -- and I want to pay less. This is what value folks mean when they say they want to buy a dollar for $0.50. You get this opportunity when emotion rules, and because emotion can drive prices down, you don't have to know the business value down to the penny. Which is good, because there is no such precision in investing!
When emotion turns from despair to mania, you can sell your dollar, for which you paid $0.50, to someone who will pay more -- and often much more -- than a dollar for it. You don't have to do this very many times to make money. You just have to make sure that you win more often than you lose.
I also sell when I see management investing money worse than I could, paying dividends when they could earn more from paying down debt, say, or buying back shares at expensive valuations.
Gardner: In the most Peter Lynch of ways, I am looking to see if the original view I had of the company -- which is always going to be a positive one given my choice to buy its stock -- has played out. If it has, I probably don't sell unless I think it has played all the way out. What's interesting is when you're wrong, and the market or the company does something different from what you're expecting. There are two cases there: a) it did better, or b) it did worse. If it did better, I'm unlikely to sell! If it did worse, that's when I start thinking about selling.
If Tom is 50% numbers and 50% experience, I'm probably 85% qualitative. The No. 1 reason I don't sell very often is because I truly look for greatness, and I think I find it. Even if things look down for a quarter, or for a year, if it truly is a great situation, I'll hold on. Netflix (Nasdaq: NFLX) lost two-thirds of its value in 2008. I didn't sell because this company is the leader in its industry, and I don't see any competition that I'm fearful of.
I primarily sell only when I've lost the belief that that company will win the battle for profits in its industry over the next three years. When I sell, I'm usually selling late. In your strength is your weakness, and selling late is related to not selling and not being willing to sell. I think I gain a lot from taking that attitude. Especially with stocks of mine whose stories don't work out, I can often be the guy who's selling near the bottom.
What's more important when you're selling: the price of the stock or the state of the business?
Jacobs: Both, of course! Price is on the surface, value is below. But if the price is greater than the value I perceive -- and that happens all the time with market emotion -- I'm happy to sell to others willing to pay too high a price.
If the business is ailing, its value is less, and I switch to a better value. If the stock price means others think it's worth more than I do, I'll sell happily. And vice versa.
Gardner: It's not just the state of the business, it's the trends in our culture and new technology. It's what I think will be the state of the business.
What was the best sell decision you ever made? Why'd you do it?
Jacobs: I have to share two!
I sold tiny Key Technology around $30. It dropped eventually into the single digits and today sells in the teens. I was able to take the sale proceeds and deploy them for greater return elsewhere.
But my favorite decision isn't an "oh, it dropped right after I sold!" story. When I owned death-care provider Alderwoods, the stock rose until it was around nine times EV/EBITDA. For its very secure free cash flow but few prospects for growth, buyers were unlikely to pay more for it. I sold on a Friday, and sure enough, the industry leader, Service Corp. (NYSE: SCI), bought it on the following Monday for 10 times EV/EBITDA! Hilarious, because the stock market is never that exact. Ever. It was a nice 70% gain in a relatively short time. People gave me credit for foresight I definitely didn't have and, fortunately, didn't blame me for missing the last few cents.
Gardner: The best sell decision I ever made was when I sold Netflix the very first time. Netflix remains a core holding in Stock Advisor, so this is a stock I obviously like very much today. I first recommended it in May 2003 and the stock had a very nice run from May to November that year. The stock went from $22 to $58 -- more than doubled in a six-month period.
At that point, we interviewed Reed Hastings on our radio show and I asked him about the future. He began describing what to me was too grandiose a vision for his company. I decided that the stock had run a little too fast too early, so I did something very unusual for me and sold a winning position after only six months. As it turned out, Netflix did decline substantially from $58 -- in fact, we rebought less than a year later at $15. So that was probably my best sell. Now it's ironic, because if we had just held that original position, today we'd be well ahead, but we took out the capital and redeployed it elsewhere.
There are very few great sells that I've made. I don't think about selling, and I don't pride myself on selling.
What was the worst?
Jacobs: Keep in mind that I never take the result as an indication that the decision was wrong. You might sell a stock only to see it go up, but maybe you put the cash in a better risk-reward situation. I never look back at stuff like that with regret. You can control your process, not the results.
Yet as always, I do have a story! I owned U.S. Global Investors (Nasdaq: GROW) from $17 pre-split into the $40s, and sold, thinking I had just handed off shares to somebody willing to pay way too much. And who can complain about that return in eight months? But it kept on into the $70s! It eventually dropped back well below my buy price, but I still think about those gains on the table.
Gardner: If you just look at flat-out dollars, it would be AOL. That fall from $100 down to $8 represented a substantial loss of capital. So that was my biggest sell mistake.
A few years ago, I recommended Martha Stewart (NYSE: MSO) in Stock Advisor. I felt that Martha Stewart was going to make a comeback as a person and as a company and I made a good recommendation to buy the stock at that time in the single digits. It was the darkest time for her, but I thought the brand had staying power and would recover. We bought around $6 and sold around $9 -- a 50% gain in a year and a half -- but the stock went on to about $35.
If you do the real dollars on that, that sell was far more costly than losing 90% with Krispy Kreme, another Stock Advisor pick. If you assume a $1,000 investment in each, you'll see what I mean. I think people obsess too much about their losers, and they don't think about what selling winners really does. That's where most people lose most of their money.
Name a stock that you wish you had sold, but never did.
Jacobs: In my Rule Breaker days, I owned biotech high-flyer Celera Genomics and like many other shareholders, saw paper gains of over 10 times in three months. Nice, except I rode it all the way up, and all the way down. Oops! I tried to write a piece for David's portfolio on what I learned, and in truth, all I learned was that I wished I'd sold. David was very nice about it.
Gardner: If it's any consolation, Tom, I also gave away all my profits on Celera. That was a real-money portfolio and it was my money.
That was an amazing stock and an amazing time. Celera is one of a number of companies that have been star-shot gainers, either for me or for our community, and that gave it back. I'm sorry to say it's not the only one. Iomega was a stock that went up maybe 20 times in value that we ended up selling for about a triple -- a good return, but we gave away a huge amount on that. And recently, Garmin (Nasdaq: GRMN) for Stock Advisor. I think I more than tripled my money and then ended up selling at cost.
For some people, this might be heartbreaking, to make 10 times your money and then sell at a loss or back where you started. It's very frustrating. All I can say is that the good news is that those are not the only times we've made 10 times our money; sometimes we've done that and then gone on to make 20 times our money. I try not to get too emotionally involved with any individual stock. If I watch a stock rise 10 times and then give it back, I think, hey, at least we found something that went up 10 times in value. That's the hardest part. Most people will never do that.
What other advice would you give to readers wondering how to know when to sell?
Gardner: One thing to remember is that you can sell incrementally. I think most people think in binary terms; they're either all in or they're all out. A lot of Fools have started to get that it doesn't have to be that way. You can average in and average out, and for some people who are very emotional, that can take away that edge.
Another thing that you should keep in mind is your overall performance. Over the past 15 years, I have beaten the S&P 500 by 11 percentage points a year, even with the big losers. By holding lots of great companies, like Netflix and Amazon, we still made a lot of money and crushed the market.
Jacobs: Here again, David and I apply different investing strategies, but get to the same result. Averaging out happens for me usually with a winner that really becomes a huge part of the portfolio. Why should I guess at the sell price any more than I might guess at the buy price? But for me, every stock fits in a portfolio, so I'm always looking at it relative to my other holdings.
I will sell completely when market emotion gives me a fantastically great sell price, or when the business changes so dramatically it undermines the investment case. But investing is rarely that obvious, so averaging out is often a great idea for any sale position.
One closing thought -- it's funny how similar David and I have performed -- his 11 points a year for 15 years and my 10 points for seven years, where we've both concentrated on what we do best. Sure, we do things differently: He picks a basket of stocks knowing that the big, technological, world-changing winners will raise all boats, and I use opportunistic value to get to the same result with fewer bust-ups, but also fewer moonshots.
The moral is that there are many ways to get to great outperformance, and in the end, David and I agree that what each of us does works for us, and can for Fools, too!
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