An excerpt from the new book 'The Dick Davis Dividend: Straight Talk on Making Money from 40 Years on Wall Street' - reprinted with permission of the author and publisher:
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The Sticky Question of When To Sell
Perhaps the most difficult of market skills is knowing when to sell.
There is no one definitive answer, no formula that applies in all situations. To sell within a reasonable distance of the high is probably the best we can hope for, and even that is easier said than done. Since we already know that, invariably, stocks go higher after we sell, it makes sense not to sell all our shares at once. It doesn’t always work and it takes longer, but the odds favor a higher average price if sales are spread out. The most common mistake is selling winners too soon and holding on to losers too long.
Investors sell stocks for many different reasons. Here are some that make good sense:
- The stock has reached your price objective, adjusted as company fundamentals evolve.
- The stock is selling at the high end of its historic price/earnings multiple — or its price/book, price/sales, or other pertinent statistical ratio.
- You need the money.
- The long - term fundamental outlook for the company has changed due to deterioration in its basic, underlying business (the change usually not knowable except in retrospect).
- The original reason for purchase (an expected buyout or anticipated new product, for example) no longer applies. Peter Lynch, famed ex-manager of the Fidelity Magellan Fund, says, “Before you make a purchase, you should be able to explain why you are buying it in terms that an 11-year-old can understand — three sentences at most. Remember this reason and sell the holding when the reason no longer continues to hold ” (gurufocus.com, “The Wit and Wisdom of Peter Lynch,” January 4, 2006).
- The time you were willing to wait for performance expires (a good dividend is likely to make you more patient while waiting).
- The technical or chart position of the stock suggests a sale (primary uptrend line or support level broken, for example).
- A guru like Warren Buffett or an adviser with a great track record sells the stock you’re holding (although his reasons may have little to do with your situation).
- Management’s integrity is under investigation by authorities (where there’s smoke, there’s usually fire).
- Selling (rebalancing) is required to keep your portfolio properly aligned.
- You want to nail down profits or protect partial profits (especially when a stock goes up too much, too quickly in response to news that may prove untrue).
- You want to limit loss when a stock drops to a predetermined price.
- There exists a threat of major, new competition.
- The departure or death of a dominant corporate leader has occurred, especially in smaller companies.
- The stock you own is near its target price and you find a better relative value elsewhere.
- The company reports a sharp unexpected drop in earnings and a weak forecast.
- You want to take some money off the table. Securing a partial profit reduces risk of loss.
Other reasons come into play in determining when to sell mutual funds. Some fund owners will sell if their fund is underperforming its peers for two straight years. Other red flags include a new manager (especially in a fund long run by a single successful manager) and a large influx of money invested in a small, successful fund (forcing it to work in an arena it’s not used to). In both cases, however, the passage of time may be needed to make a fair evaluation.
Aside from needing the money, none of these reasons to sell stocks or funds are carved in stone. In every case there may be extenuating circumstances that fully justify holding on. If nothing else, however, they should give rise to a rethinking of your position.