As you might know from reading my posts, I firmly believe that the best investing results are achieved through long-term investing.
Owning companies for a long time has proven to be a profitable investment strategy. Although the average holding period for a stock has dramatically shortened over the past decades, one shouldn’t sell their holdings for just any reason.
Then again, even for a die-hard buy-and-hold investor, there are some occasions when selling a stock might be the best solution.
Here I’ve gathered here the 7 reasons when to sell a stock – or at least when to consider it.
The Fundamentals Have Changed
For a long-term investor, the usual reason for selling a stock is that there’s a change in the company’s fundamentals. In other words, it ain’t what it used to be.
Let’s imagine you bought a company that was highly profitable, had a great business, and had a strong balance sheet. Then the company started to use its excess cash to purchase other companies that it had no idea how to run.
Because of this, the profits plummeted, its balance sheet started to grow weak because of a high amount of debt, and it had no money left to invest in its original business.
I know it goes without saying, but this is why investors should follow the companies they invest in.
One or two bad quarters make no difference in the long term, but a gradual deterioration of a company’s core business most certainly does.
When you notice that things are going bad, it might be time to sell a stock. You can always buy them back if the company makes a successful turnaround and things start to pick up again.
The challenge is to know whether the change is permanent or is it just a temporary slump.
Especially during bear markets, it’s best to find out whether the stock price declines along with the stock market or if there is something that’s fundamentally different on a firm-specific level.
In most cases, there’s nothing fundamentally wrong. When the stock market goes down, everyone suffers. This goes double for cyclical companies.
Also, sometimes it’s useful to think about what made you buy the stock in the first place. If you bought a turnaround company, for example, that has turned around and failed to achieve the results it was after, it might be time to let the company go.
If you bought a stock because it had a certain story behind it, it’s worthwhile every now and then to check if the story has changed, and whether the company is still something you should invest in.
Unpleasant Surprises
Some things we see coming, others we don’t. When we witness a company with gradually declining profits and market share, we have plenty of time to sell the stock.
On the other hand, the most devastating surprises are the ones we don’t see coming.
In investing, these may include things like cooking the books, faking research results, or some other innovative approach to business that repels customers and investors.
The key thing here is to decide whether the surprise is big enough to ruin the company.
In most cases, companies recover amazingly fast from these scandals since people tend to have shorter memories than they care to admit.
Then again there are some scandals like The Enron Scandal, that are so massive they bring the whole company down.
On these occasions, investors might need to act fast if they wish to sell their stocks.
The Company Fails to Meet Expectations
When investors invest in a company, they expect the company to do well.
Unfortunately, sometimes things don’t go as planned.
A common example of this would be a pharmaceutical company that promises a ground-breaking new drug but fails to get approval.
The same goes for aggressive growth companies with cutting-edge products or services that never manage to turn a profit. Or mining companies that seem to never strike gold. Literally.
If the company fails to deliver on the very thing that it’s supposed to deliver, it might be time to cut your losses and sell the stock.
There’s no reason for holding a losing stock and accumulating additional losses if there’s nothing positive in sight. Also, depending on your investing strategy, you can use the losses for tax loss harvesting.
What’s important in these situations is to analyze whether the failure has a great impact on the company or not.
In the short term, these failures always have a negative impact on the company’s stock, but they can also be great buying opportunities if the company has other promising ventures on the way.
Mergers and Acquisitions
When a company announces they are either being purchased or merging with another company, the current market price usually goes up.
Although the two are different terms, they’re almost synonyms nowadays. A merger is two different companies merging (Company A + Company B = Company AB).
An acquisition is one company acquiring another (Company A + Company B = Company A).
Mergers and acquisitions usually involve a premium that can be quite tempting for investors. On these occasions, many investors decide to sell stocks.
The important thing to do here is to analyze whether the change is good or bad for your company.
If the fundamentals change for the better, the premium may not begin to describe your future earnings.
On the other hand, you might find out that the fundamentals are not going to hold, and the move offers a perfectly acceptable opportunity to sell.
Depending on your investing strategy, you might have a certain price target for a stock. If a stock reaches your target price because of the premium paid, it’s a tempting opportunity to sell stock.
You Need the Money
Ok, so sometimes you just need some extra money to buy something you’ve wanted to buy for a long time. There’s nothing wrong with selling a stock and buying something. After all, it’s your money.
The thing is that not all money is the same – some are more expensive than others.
Paying for something by selling stocks is probably the most expensive form of money you can use.
If you sell stocks for, let’s say $10 000, you’re not only paying unnecessary taxes, but you’re also losing all the returns you would’ve gotten if you’d held the stock. This means that if you buy something with stock money, its real price is a lot higher than the number in the price tag.
This is not to say you should live your life wearing a potato sack or live in a barrel, like Diogenes.
This is just to remind you that the opportunity costs of a purchase made with a stock sale may be more substantial than one might think. It’s the reason why selling stocks to buy stuff is not the best investment advice out there.
There are, of course, more important things than money like health, family, etc. Not everything can be measured by return rates and opportunity costs.
If you need the money to pay for something that’s absolutely necessary, you can justify selling your stocks.
This one is straight from personal finance basics, where you separate your needs and wants in your budget.
It’s ok to spend invested money on things that you absolutely need, but I would recommend not using too much of your invested money on non-essential purchases. Unless, of course, you REALLY want it.
Rebalancing Your Portfolio
One of the most common reasons for selling a certain stock is that it starts to dominate your investment portfolio after the stock price has gone up. In most cases, it’s a positive problem, since it means that one of your stocks has done remarkably well.
The reason why investors tend to sell a stock in these situations is that having a certain stock dominate your portfolio increases your risk level.
Also, if the stock price has gone up, let’s say tenfold, it might mean that the stock has become overvalued.
Of course, for some investors, this is not a problem. If you have a high risk tolerance and know your companies well, there’s no reason why you can’t have a highly focused portfolio. Nevertheless, for most investors, it might be best to stick with a more diversified portfolio.
There are also rebalances that are based on your investment strategy. Some investors follow strategies where they divide their portfolio into different portions like 60% stocks and 40% bonds.
The idea is to keep the percentages in your overall portfolio somewhat constant, so if stock prices start to rise, you would either buy more bonds or sell your stock holdings.
It’s a sort of automated balance system where you sell the asset class that has become overvalued or buy more of the assets that are undervalued. Rebalancing your portfolio is a perfectly acceptable reason to sell stock.
The Stock Has Become Overpriced
“Buy low and sell high, that’s my motto” -Homer Simpson
The quote above was from the Simpsons episode where Mr. Burns sold his power plant and all the employees got rich from selling their stocks. Everyone else but Homer, that is, since he sold his stock before the price went up and only got $25.
So, the lesson here? Well, the first lesson would be that the early Simpsons seasons were pure gold.
The second, and maybe even more important one is that it’s extremely difficult to buy low and sell high. Obviously, the best time to buy a stock is when the stock trades below its true value and to sell when it trades above it. Unfortunately, it’s not a simple task to define whether a specific price is high or low.
There are times when stocks are ridiculously overpriced, and yet it can be unbelievably hard even for experienced investors to sell them.
The problem is that you can never know for sure, whether they are truly overpriced, and whether the prices continue to rise or not. It’s especially hard for growth companies that are overpriced year after year, and yet they keep growing and beating expectations.
Then again, sometimes the valuation of a stock is no longer in line with reality, and it truly is the right time to sell.
One way to think of it would be that if you wouldn’t own the stock, would you buy it now? If it’s not tempting, then it may be time to sell.
It’s also worth remembering that you don’t have to sell anything. If you have a feeling that a stock is overvalued, you can sell a portion of your holdings to give you peace of mind.
