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Selling a Stock

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November 29, 2006 – Comments (2)

Selling a stock should be very similar to buying one. There should be an understandable, logical reason behind it. If there isn't a good reason for selling it, why sell? Like buying a stock, selling one should have a point, a reason, behind it to make any sense. You must find that point and be confident that it is a good choice for your portfolio. There are many different points you could think up, but the following points are those that make me no longer feel a company is the best choice for investing in (my investment dollars), and my explanation of those points.

~ The initial reasons why I first purchased the company are no longer there. This means that if I invest in a company because of its main product but after a year that main product is no longer “the product”, the reason for my investment is no longer there. There are many different cases and reasons that can lead to you investing in a company, and this is why it is good to keep track of them. Companies don't always stay the same, and if they change in a way you don't really like, there is no good reason for you to continue to hang on to your investment.

~ The company is no longer doing what I feel is right for long-term success. This is something that is oriented around management. Keep track of what your company is doing. If it is a company that grows primarily through acquisitions of other businesses and it makes a purchase for what seems to be a large amount, it probably isn't the best thing for long-term success (a company who grows from acquisitions should look for undervalued businesses, just as the individual investor does). Just keep a watch on the company's movements to see if you think management is doing the right things for success over the next 15 years and beyond.

~ The company has ventured into a new market that is not close to its “core business” and just plain doesn't make sense from a business or investment perspective. This is what Peter Lynch calls “deworsifying.” Some examples would be if Coca-Cola venturing into the lumber business, Starbucks became a tire retailer, simply if a company goes into an area completely outside of its expertise. When this happens with a business, it either means management has no idea how to run the business, or that the company has run out of ways to grow. I'd strongly suggest to stay away, or sell, companies who have gone this route to expand. I find an effective way to do this is to jot down your own description of the company's business or service. If you have any doubts, say, a year or two after your first investment (or anytime), again jot down your own description of the company. If the AT&T you invested in is now an oil driller, take it as a huge caution sign with your investment.

~ The fundamentals have changed considerably in the wrong direction. This is a fairly simple one. If margins decrease 50% while debt doubles and cash shrinks, you should see if the company is managing its money right. But look through several factors, not just one area. For instance, if you only focus on debt and notice there was a large rise in debt, don't use that as your final conclusion. That debt could have been from an acquisition that will end up more than paying off that debt in the future. Always make sure the fundamentals haven't changed just for one quarter or the short-term, because that is normal with any company (or most companies). But, if the company clearly is going the wrong direction with the fundamentals, that'd bring me very close to selling at least a good part of my position in the company.

~ Several executives have recently left the companies to "spend more time with their families" or to "pursue other interests." If this comes up, there is usually something behind it that the company doesn't admit, and probably would do anything to avoid mentioning it. If only one executive leaves, I wouldn't make a big deal out of it. But if you see two or more leaving in the same general timeframe, I'd take it as a huge caution sign. If executives really believe in the future of a business, it doesn't make sense for several of them to leave, does it? This is, of course, if the reasoning behind their leaving isn't convincing (if you find yourself questioning why they left after reading about it, that's usually a good, accurate sign that there is something investors don't know about going on “inside”).

~ Management is clearly not being honest with shareholders. If management is selling considerable amounts of their holdings I'd also feel queasy with an investment in the company (this data is also available on Yahoo! Finance). This is similar to the above point. But, thanks to Yahoo! and other financial web sites, you can see whether or not management is selling stock or buying it. If you see a steady stream of sells with several different executives and managers (not just one or two) that makes up a large chunk of total insider holdings, I'd be concerned. I wouldn't let this one reason make an automatic sell decision for me, but if it was with a business that had some other questionable aspects to it, I wouldn't feel too comfortable with keeping my investment in that company.

~ As I already mentioned, if I start asking myself, "Why the heck did I invest in these guys in the first place?!?" This is probably one of the easiest ways to tell if you should consider selling or not. I believe it is the main point, the basis, to looking into selling.

~ And what I feel is most important: If I am no longer comfortable with the company as an investment in my portfolio. If you aren't comfortable with a company, you shouldn't be invested in it, period. I don't care if it was recommended by a great advisor or if Warren Buffett is invested in it; if I'm not comfortable with it as an investment, I stay away from it or sell it. This is because if you aren't comfortable being an owner in a company, why stick with it? Only invest in companies you are more than comfortable with, because if you don't, you probably won't be able to keep that investment for the long-term without feeling queasy of doing so.

Every one of these points should take further research, but they are the primary reasons for me to at least consider selling one of my investments. I'm not a fan of selling stocks, and try to do so as little as possible. This is because I really view investing in stocks as becoming an owner of a company. One thing I find to be helpful when investing in stocks: imagine you are buying the entire business. This helps immensely because A) You view short-term movements much differently; B) You don't become as interested as “playing” those movements (you don't see Warren Buffett continually buying and selling the same business, do you?); and C) It really enforces the thought that you are an owner of the business, which is the way stocks should be viewed (at least through the eyes of a long-term investor).

One thing you will notice with my selling points is that price has nothing to do with my decision to sell. The only reason I even consider selling because of a stock's price is if it's price has gotten outrageously overvalued to its business value. But even when this case pops up, I just let the investment ride and buy more of the business if it falls lower when the market notices it's overvalued. Don't sell your winners if you are still comfortable with them. If you still love the business and the direction the company is heading in over the long-term, it makes absolutely no sense to sell because it has been a good performer in your portfolio. It has to do with the comfort level: if it gets up to a price where you are no longer comfortable with, I think it's a good idea to sell. The comfort level has got to be as high as possible, and that has to be your absolute top priority. Don't let the opinions of others affect your investment decisions. It matters how comfortable you are with the business, how confident you are with the future, and what you think you should do with your investment. This is why it is so important that you know why you invested in the company in the first place. Then you can know whether to buy more, sell, or hold (the common question from beginners). Your opinion is the one that should effect your investment decisions, not your cab driver, not me, no one but you. It is your money, and it is important that you know what you are doing with it. This will help you an amazing amount with future and current investment decisions. Basically, it's good, no, not good, but extremely important, to know why you first invested in a company, and it will make your future a heck of a lot easier.

2 Comments – Post Your Own

#1) On November 29, 2006 at 4:59 PM, TMFSpiffyPop (99.39) wrote:

David, a very nice primer for selling, all contained in an early blog entry of yours! I enjoy your stuff and love to watch the way you keep learning. Very impressive. Also, your CAPS Score is about 7 times mine right now... so you got that going for ya, too. ;)

Foolishly,

David G.

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#2) On November 29, 2006 at 6:13 PM, TMFPencils (99.81) wrote:

Hey David!

Well, needed something to get this blog rolling. ;-)

All I can say is that you and Tom have been my role models all along since you really got me interested in stocks last year. It's just been a really fun time talking with you guys and learning from you over the past year.

My CAPS score might be beating yours, but I bet your real portfolio is whuppin' mine with returns. ;-)

Best,

David K

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