To Sell Or Not To Sell - That Is The Question

Reprinted from the March 1995 Better Investing®

by Leonard I. Reiser
Technically Speaking

Brokers and advisory services can keep you hip-deep in techniques and approaches for buying stocks, as well as specific recommendations. But few offer help with respect to when to sell. Public libraries are similarly full of books on buying, but try to find one giving equal time to selling.

When an investor sells a stock and invests in another security, four things can happen, and half of them are unpleasant:

1. The stock that is sold goes up, which is deflating and discouraging.
2. The stock that is sold goes down, which is good, at least psychologically.
3. The stock that is bought with the proceeds of the sale goes up, which is the ideal "switch".
4. The stock that is bought with the proceeds goes down, which is definitely depressing, both psychologically and financially!

If your odds are only "even money" on success, the best rule to follow is: Don't sell unless you have a valid reason.

On my personal list, I have seven "right reasons" for selling. (Editor's Note: For additional comments, readers might refer to Chapter 15 in The NAIC Official Guide: Starting and Running a Profitable Investment Club, "Deciding When to Sell.")

1. Improving the quality of your portfolio. Seldom, if ever, should you lower the quality of your holdings.
2. Adverse management change. If the young, aggressive, imaginative management team you thought so highly of are beginning to leave the company, or if corporate "raiders" have taken control and ousted competent managers, then it may be a good time to pull out the funds you have invested in the company.
3. Declining profit margins or deteriorating financial condition. These are the kind of things you should be looking for in each quarterly or annual report put out by the company. If the decline or deterioration looks to be more than a temporary or short-term situation, get out.
4. Competition becoming severe. Some companies have diversified successfully to prevent competition from ruining their future potential, while others have tried to stay ahead of their competitors by wisely reinvesting a percentage of their profits into a strong research/new product development program.
5. Single product or single customer company. In some cases this is not detrimental, that is, when the company is the industry leader. In other cases, this can be a formula for sudden disaster unless the company is planning diversification efforts to reduce dependence on the lone product or customer.
6. Improve the upside potential or decrease downside risk. This is always sound strategy, provided you don't start getting trigger-happy and turn into a trader rather than a long-term investor.
7. Disappointing growth rate or company proving to be cyclical. Some companies with great promise never seem to deliver, while others are given the "growth stock" label at the height of their temporary popularity when in fact they were only cyclical stocks at the peak of their industry's profit cycle.

I can also think of five "wrong reasons" for selling.

1. You're tired of doing nothing. If you bought the stock after careful homework and you are continuing to follow the company closely, have the courage to hold on.
2. The price is down. Recheck your fundamentals and decide whether the decline is justified by particular facts or whether it is due to general market weakness. If the latter seems to be the case, you may have an excellent opportunity for a repurchase to average down your cost.
3. Taking a small profit. By taking a small profit, chances are that you will miss the opportunity for even bigger profits by staying with the stock. Remember, if you keep cashing in your small winners and staying with your losers, you'll eventually wind up with all losers. The pro's follow the rule, "Cut your losses short and let your profits run."
4. Temporary bad news. Temporary bad news is usually a great buying opportunity, but again you must evaluate the news and facts to determine whether the situation is indeed only temporary.
5. Price is unchanged. If you bought the stock for the long term, then give it a reasonable period of time to start showing its stuff. In the meantime, recheck the available financial data to see if the stock should be repurchased.

Finally, consider these four "wrong reasons" for not selling:

1. Emotional attachment. Don't feel married to any stock. It doesn't feel married to you just because you bought it.
2. You hate to admit a mistake. If it was a mistake, admit it and get out like the professionals do, to avoid even bigger losses in the future. If it doesn't appear to have been a mistake originally, but rather a case where the situation changed after the purchase, then you should make a new assessment of the situation.
3. You hate to take a loss. The best loss is often the quick short loss, instead of waiting in vain for a rebound that may never come.
4. Tax reasons. This is a minor factor for most of us, but it can often be turned into a positive by offsetting any loss with a long-term profit in another stock that has met its objective or is vulnerable to a decline.

One of the few books on selling, and one of the best I've seen in years, is "When to Sell," by Justin and Robert Mamis, which provides specific rules and strategies. This book is fairly old, but possibly still available in larger public libraries. One of the main themes of that book, repeated several times, is that no system or procedure for selling will succeed if the stock wasn't bought at the proper price. "Smart selling has its roots in smart buying," is the way the authors expressed the prime directive.

Leonard Reiser is retired senior project editor with Lawyers Cooperative Publishing, Rochester, New York. His Technically Speaking column focuses on companies that are of interest to both fundamental and technical investors in the current market.