It is very easy to buy a stock. Selling a share or stock though, especially if it has lost value, is a much harder process because of the emotions involved. Knowing when to sell a stock, and actually doing it, is tough and that is why most people like to buy and hold stocks. The ability to sell shares at the right time, up or down, is what differentiates successful investors from mediocre ones.
Rather than cut ones losses, most people – including me – hold onto losing stocks when we really should have sold much earlier. A lot of this is driven by the emotions around selling a stock when it is down, in that you feel like you’re giving up. Similarly, when a stock’s price is soaring, people are less reluctant to sell because they don’t want to miss any upside, enjoy seeing the share price rise every other day and/or feel that it will keep rising forever, especially in a bull market – even though that can be the best time to sell.
There’s nothing wrong with a buy and hold strategy if you are investing in a well run company and your horizon is 5 to 10 years, but even then you will get dud stocks and you need to learn to say “sell”. The market’s ongoing volatility might be making you want to say, “Sell it all. I’ll sit this out until things calm down.” But you shouldn’t let fear guide your investment decisions. Instead, look for these telltale signs to help you decide if the time is right to sell a stock.
1. A change in the company’s fundamentals. Usually the best clue for when to sell a stock comes from the company, itself. If a company’s earnings stop growing, if its top management quits or is forced out, if it stops creating new products, or its products aren’t receiving regulatory approval, the company’s stocks could be headed for a fall.
One sure sign of trouble is if a company is having cash-flow problems. A cash flow statement gets to the guts of a business – the cash it receives and the cash it pays out. It’s especially handy when researching companies that don’t have profits. You can find the information in the company’s annual reports (via their website normally). If you are with an online broker, they should also have this information available for free in their “research” sections. Look for the following changes in free cash flow:
- Is operating cash flow growing slower than net income?
- Is inventory rising faster than sales?
- Are receivables rising faster than sales?
These are early warning signs that it might be time to sell the company’s stock.
2. The stock’s too hot. If a company’s stock price is soaring but its fundamentals, such as earnings growth, aren’t following suit, it may be time to sell. A stock with an especially high price-earnings (P/E) ratio may be the victim of investors’ unrealistic expectations. The P/E is calculated via dividing the current share price by the company’s earnings per share and is also available at most finance sites. You can compare a stock’s P/E with that of the overall market, the average P/E of its industry, or against the company’s past P/Es. If the company’s ratio is unusually high, it could have a hard time sustaining that price.
Experts recommend picking a target P/E when you first invest in a stock. If the price jumps but the earnings keep up, you won’t have to sell. This method can help give you the discipline to dump the stock before it becomes overpriced.
3. The stock’s not keeping up. The market’s rallying, but your stock isn’t. This can be a sign to sell, especially for popular or trendy stocks that tend to move in sync with the market. For example, if stock was $100, drops to $80 but doesn’t bounce back or even falls below that level, sell.
4. The stock is taking over your portfolio. If you went into your stock purchases aiming for diversification, revisit your portfolio once a quarter to see if your holdings are still in balance. If you have one or two big winners and their futures still look bright, you may want to consider taking some profits off the table — and adding to your other holdings — just so you won’t be overexposed if the unexpected happens. My rule of thumb is to sell half the holdings of a stock that has doubled, so that at least my initial investment is recouped.
Ideally, you sell a stock when it’s up so you can make a profit. But sometimes you have to cut your losses and sell when a stock is down. However selling for a loss may not be all bad, especially if you have made some profits (capital gains) during the year. Losses offset capital gains — from other stock sales or managed fund distributions — and, if you have more losses than gains, up to $3,000 of net loss can be deducted against other kinds of income (US only). Part of your tax planning strategy should involve reducing your capital gains exposure by assessing and selling the under performing stocks in your portfolio.
In today’s volatile market, it is even more important to know when to sell your dud stocks. The right time to unload stocks is one of the toughest calls investors have to make, but holding on to them could mean you end up with nothing but a story of regret.