When To Sell A Stock

Consider this scenario – one of the stocks in your portfolio has declined by more than -50% in value. Should you sell the stock to cut your losses, or should you continue holding on to it in hopes of a turnaround? Similarly, if one the stocks in your portfolio has done superbly well, making a decision on whether to sell it or not can be just as hard. We've all been there – a crossroad in our financial journey where we are faced with the dilemma of selling or holding a stock that we have invested our hard-earned cash in. While buy recommendations for stocks are prevalent, few offer much advice when it comes to selling stocks. Here are some guidelines that investors can adopt when deciding whether to jettison a stock from their portfolios.

Rapid Price Appreciation To Excessive Valuation Levels

Before investing in a stock, it is always a good idea to have a rough grasp of its intrinsic value, which is the price level at which an investor thinks the stock is worth, given a complete understanding of its business characteristics, financial performance and other variables that may not be accurately reflected in the current market price. When a stock experiences rapid price appreciation above its intrinsic value, it may a good idea to sell off the stock and take profits as the price of an overvalued stock is more likely to fall in the near future than to rise. The proceeds from the sale can then be reinvested into a significantly undervalued stock. While it is entirely possible for the price of an overvalued stock to continue rising, investors should have the discipline to hit the eject button and not let greed cloud their investment judgment. After all, a bird in the hand is worth two in the bush. If you're unsure, consider taking profits slowly by selling some of your stock holdings at regular intervals, although this approach can potentially ratchet up your transaction costs.

Deterioration In Stock Fundamentals

While it is important to keep track of a company's stock price relative to its intrinsic value, it is also equally crucial to have a firm understanding of its fundamentals, as stock prices are determined in large part by a company's future earnings power. In other words, a company that is able to grow its value over time is very likely to see its stock price appreciate in line with its earnings growth. Investors should consider selling a stock if they believe that the company's long-term earnings power has been permanently impaired. For instance, changes in the competitive landscape of an industry can cause a company to cede significant market share, and a sell decision is warranted if the company is deemed unable to cope with the increased competition. However, making a judgement call on a company's long-term earnings potential is not as straightforward as it seems. The issues plaguing a company can sometimes be temporary, such as cyclical headwinds and sluggish economic growth, and profitability (and consequently, its stock price) is likely to pick up over the next few years as these factors subside. As such, investors should always try to understand the factors that are hurting a company and its stock price, and determine if such factors are temporary or permanent.

Better Opportunities Exist Elsewhere

Sometimes, a sell decision can still be warranted even though there is nothing wrong at all with a company and investors still believe the stock to be of good value. The reason for that, is simply because better opportunities exist elsewhere that gives investors more bang for their buck. When faced with a limited amount of capital and many investment choices, investors need to make decisions that maximise the profits earned with their available capital. The decision to invest in a particular stock could mean that the investor passes up on the opportunity to invest in other potentially attractive stocks. As such, when a stock investment opportunity comes along, investors should always compare its potential gains with that of their existing stock holdings. If the alternative is more attractive, then it makes sense for investors to liquidate their existing stock positions and invest the proceeds into the alternative.

Stay Focused On The Long-Term

Nothing in the stock market moves up or down in a straight line all the time. In fact, occasional swings in the market are all part and parcel of stock investing. As long-term investors, fear is never a reason to sell. In fact, investors should welcome volatile times as opportunities to accumulate quality stocks on the cheap. Similarly, selling good-performing stocks in pursuit short-term income and profit gains can also be detrimental to an investor's long-term investment performance. When contemplating a stock sale, investors should always maintain their objectivity, making such decisions based on a company's valuations and fundamentals, especially when its stock price is moving contrary to expectations. By putting aside our emotions, we make better investment decisions that can go a long way towards achieving our financial goals.