To Sell or Not to Sell...
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!”