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To Sell or Not to Sell...

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January 02, 2014 – Comments (9)

An interesting question recently came up on Pencils Palace, my discussion board on The Motley Fool, regarding when it is appropriate to sell a stock. This particular user owned a stock that had increased over 500%, leading this one stock to make up 30% of his portfolio. While there are a variety opinions on when (if at all) to sell a portion of a winning investment, my perspective on this issue has evolved based on personal experience.

It can be a normal tendency for investors to get nervous after a stock has quickly increased in value and become a major position in one's portfolio. When a business/stock does very well, our instincts tend to lean toward selling the high-rising stocks and shoveling the money into something else. This line of thinking is what led me in the past two years to sell a portion of my Netflix position at $245 and most of my Chipotle position at $294 and $319. Netflix shares recently closed above $367 and Chipotle over $530. Whoops.

Ask yourself this critical question: Are there companies that offer brighter prospects and more potential than my current winning investment?

Looking back on some of my investing decisions, many times I sold portions of quality businesses (my best investments) only to invest in businesses that did not offer near the potential of my previous investments.

The bottom line is that business fundamentals and prospects, not the stock price, should be the primary influence on our investing decisions. This goes for buying or selling.

Have the business's fundamentals and prospects dramatically shifted since you first invested? Is there any reason to think the long-term potential of the business is diminished? If the answer is "yes" to either of those questions, it may be a good idea to consider selling a portion of the investment.

If, on the other hand, the business remains a quality organization with a promising future, there is good reason for the stock to make up a hefty chunk of your portfolio. If the fundamentals remain intact and the company's future looks bright, you might be hard-pressed to find a better place for your investing dollars.

Remember what Peter Lynch said: "All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minuses from the stocks that don’t work out."

We want our investments to go up. Curious then, isn't it, that we sometimes get it in our heads that we should sell our winners and pump the money into our laggard investments.

Think of it this way: hopefully, at some point, all of your investments will be multi-baggers. The fact that one got there sooner than the others shouldn't be the only basis of trimming your position. Is it more likely than not that the business will continue to perform well and lead to a market-beating stock over the next 5-10 years and beyond?

This is a great problem to have as an investor. Not many people would blame you for locking in some gains after a stock doubled or tripled in value. If anything, though, in hindsight I would have been far wiser to keep (or even buy more of) my winners rather than selling and adding to other companies. Another great quote from Peter Lynch to remember is, "Know what you own, and know why you own it."

If you can't sleep at night because a large chunk of your portfolio is in one stock that has done exceedingly well, that may be a good reason to take some gains. However, if you remain confident with the business's long-term prospects -- why cut short an instance where you beat the Street to a great business?

As investors we hope to have many more of these sorts of investment “predicaments!” 

9 Comments – Post Your Own

#1) On January 02, 2014 at 7:04 PM, jiltin (26.83) wrote:

Nice Post, awallejr suggested me to increase the horizon level for long term investment. 

If the company is solid and healthy, it is good to keep it.

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#2) On January 02, 2014 at 7:36 PM, awallejr (83.92) wrote:

I always had issues with Cramer on this very topic.  He would always state no one ever got hurt taking a profit.  Except that isn't neccesarily true as you point out.  You can close out a solid winning position but then what to do with the proceeds?  You could wind up putting it into a bad investment and lose.  So you did get hurt taking a profit.

If the thesis still holds true for your pick let it be.  All your really wealthy businessmen have the bulk of their worth tied into their own company and stock.  If you were lucky enough to have bought MSFT on the ground floor the right choice was to just let it ride.  Same with AAPL and many others.

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#3) On January 02, 2014 at 11:19 PM, Mary953 (73.63) wrote:

I get attached to those stocks that perform well and don't want to sell them at all.  I have had to retrain myself to put stops into play that will allow me to keep most of the profit if the companies start a slide into short term oblivion.  The hardest part for me has been to realize that even when stocks like Apple or Netflix nosedive back toward the basement levels, stops can protect my profits and give me the ability to buy back in when the drop ends and the stock begins climbing again.  With that methodology in place, I just have to concern myself with two questions: Do I like the product or service provided by the company?  Is the company sound enough to deliver that product or service in a profitable manner?  If those are both true, then the rest is just riding out the ups and downs.

What can I say? I get distracted by pretty shiny objects!

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#4) On January 03, 2014 at 12:13 AM, HarryCarysGhost (99.70) wrote:

I've had the problem of having one stock over weighted in my portfolio.

At one point Visa was 50% of my investments due to share appreciation and the fact that I would buy it like crazy anytime it was under $75.

My solution was to just let other stocks catch up. Since I'm always adding new money this was done in a fairly short amount of time. (now it's closer to 30% V 20% KO and a 50% basket of  about 7 others)

Why would I wan't to sell something if my thesis for buying was still intact.

Cheers. 

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#5) On January 03, 2014 at 1:36 AM, awallejr (83.92) wrote:

Harry!  That 'Ol Cubbie fan lives.

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#6) On January 03, 2014 at 10:45 PM, awallejr (83.92) wrote:

Oh and Mary I meant to reply to your comment.  You are absolutely right to use stop losses to protect gains.  The thing that worries me are those flash crashes that happen which can hurt people using them.

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#7) On January 06, 2014 at 2:50 AM, Zack907 (99.39) wrote:

@ Mary953 or awallejr, I don't understand the logic of a stop loss. If it is a good company to be invested in, why would you sell it? If you have somewhere better for your money, why wait for the price to go down?

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#8) On January 13, 2014 at 12:02 AM, awallejr (83.92) wrote:

It isn't really an intended sale Zach, it is a sale to protect gains.  Stocks correct.  One thing you hate doing is giving back those profits.  So your stop loss gets taken out then buy back at a lower level.  Personally I don't use them for picks I have a multi year outlook on.  I can handle the swings.  Others, however, can't.

T shirt I should wear should say "I survived the crash of 2008/09" heheh.

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#9) On January 29, 2014 at 3:49 PM, Mary953 (73.63) wrote:

I was out of the market for a period of months with an injury.  If I had been smart I would have put stops in place.  As it was, both Netflix and Apple tumbled badly.  I pulled out having lost 1/3 of my portfolio.  I am now trying to build it back up.  And I now use stops to keep those big drops from happening.  When a lesson costs you thousands, you should apply that lesson.  As it is, the stops are loose, but they are there just in case.

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