This is not much of an actual post as it is an information gathering session. I have recently been consumed by the thought of when should you sell a stock. Specifically, can you use selling a stock that has experienced an increase in price to enhance the overall value of a portfolio? If so, how???
I started thinking of this after reading an article over at Seeking Alpha which you can find here. I’m working on an article and trying to clarify my thoughts, but I feel they are even less clear than before.
So, I’m reaching out to you dear reader in hopes that you will share with me what your thoughts are on selling to enhance your portfolio. Should you? Under which circumstances would it be advisable to do so?
I look forward to hearing your responses.
The Stoic Investor 
Hi Stoic, great site you have here. Keep up the great work!
As for when to sell, I only do it under one of three circumstances.
1) Wrong Facts: There are times after a security is purchased that the investor realizes the facts do not support the supposed rosy reasons of the original purchase. If the purchase thesis was initially built on a shaky foundation, then the shares should be sold.
2) Changing Facts: The facts of the original purchase may have been deemed correct, but facts can change negatively over the passage of time. Management deterioration and/or the exhaustion of growth opportunities are a few reasons why a security should be sold.
3) Scarcity of Cash: If there is a shortage of cash available, and if a unique opportunity presents itself, then it’s reasonable to sell to fund the purchase.
These 3 basic rules are from Philip Fisher and they’ve served me well over the years. Why complicate things when you don’t have to right?
I like to look at stock valuation this way. If a stock appears expensive today it may look cheap tomorrow given its longer-term earnings power, comparable company ratios and durable competitive advantage. Plus if you sell then you have to pay taxes to Uncle Sam and lose the chance of additional compounded capital gains and dividends.
Also this video, “http://www.youtube.com/watch?v=WVqyCRYBieI” gives a good explanation of why not to sell.
That’s my take. Cheers!
Henry, thanks for the stopping by and the kind compliment! I like your method of determining when to sell. The tax factor should always be a consideration, but never the only consideration.
Hope you had a great weekend!
I’m not a very experienced investor myself. But if you feel a certain stock is definitely not worth its current value (it is overvalued), then you can either wait until everyone else agrees with you (and stock price goes down) and you won’t make a profit, or you can sell and use that money to buy other stocks that are undervalued or at their value.
Big problem is, I think, that you are never sure about the true value of a company. They may have done great for years but their new products will turn out to be flops, or, the other way around, they may have been doing not so great but they are currently developing a new product that will be a big hit (or just “do well enough”). Can you tell what will happen? I can’t. Plus even if the company actually is doing fine, investors may think otherwise and the shares will plummet anyway.
I don’t know much about capital gain tax, the system works very differently in the Netherlands.
I believe rebalancing a portfolio every few months / every years helps in not exposing your money too much to overvalued stocks. After all, it will mean you will sell some of the assets that have gone up in value.
Thanks for stopping by and contributing to the conversation. It is hard to determine if and when something is overvalued. It was also one of the objections raised against selling a stock in the comment section of Robert’s article. I’m curious of how much weight should be given to it at all…
Hi Stoic,
Good to have you back. It is always interesting to read your posts.
Occasionally I sell stocks. In fact I am about to sell 2 of my holdings for the
following reasons:
1. Fundamental negative change to the business environment or operations of the company. Case in point – Husky Energy. I purchased the stock with the view that it is in the energy space, has international presence, pays a reasonable dividend, etc.
However natural gas and NGL prices have come down considerably after fraking technology came along. This is a commodity business which is highly capital intensive. When Husky started falling short on cash the firm decided to offer a dividend reinvested plan. With many investors and a controlling shareholder switching to it Husky pretended that is has enough cash whereas what they do is printing shares thereby diluting existing shareholders. Dividend has been frozen for years. In a mean while earnings are not growing nor do I expect them to in the mid-term future unless natural gas increases in price – by all means not a guaranteed event. To keep Husky in my portfolio would mean gambling on natural gas going up … which is not my strategy. The down side is way more likely and thus I will sell.
2. I agree with the article from seekingalpha that an overvalued stock should be sold, but I have one big CAVEAT – the company should have limited to no growth opportunity.
Case in point – utility company Fortis Inc. It is in capital intensive business and being a regulated utility does not have much growth potential. The dividend increases in the last few years were small – in the vicinity of 3% per year. It does not buy back stock. Cash from operations is spent on CAPEX with no visible growth expected. Fortis has gone up in price by 20%+ since I bought it and yields 3.6%. With no expectation of growth I cannot justify keeping it in the portfolio.
On the other hand Coca Cola in my view is also overvalued. Yet I will not be selling it. KO is a high-margin, internationally diversified business that stood the test of time. It has plenty of growth opportunities in the East, it keeps increasing its dividends, etc, etc. Thus I won’t be selling Coke any time soon despite my firm conviction that it has gone up too high.
One of the reasons for not selling an overvalued company is the re-investment risk. There are only so many really good stocks. To sell one and buy the other at the right time is what millions of people do around the world. How many of them are successful at it?
Regards,
AverageCFA
Average CFA. Thanks for the compliment and sharing your thoughts on selling.
This is where my doubt becomes aroused. I’m convinced that it is difficult to find appropriate places to put the profits you have taken off the table. I agree with what you say about the millions. Here is my question: Are they unsuccessful b/c they attempted to sell high and buy low or was their timing off? What I mean is did they sell because a stock had dropped in price only to buy into one that was overpriced? I believe they do and with devastating consequences to their portfolio.
My aim is to determine if it is possible and what set of circumstances need to be present to make it work? It is times like these that I wish I were more of a mathematical thinker…
I hear you Stoic. It is tempting to take some profits from an already appreciated investment and buy another undervalued stock. In my view this is possible on a rare occasion, but not frequently.
Out of those millions of hopeful investors we mentioned above hundreds of thousands are very smart and disciplined. They are all chasing a few hundred companies. To find a mispriced opportunity is difficult because of that. Moreover, we are all prone to judgment errors not to mention a myriad of unforeseen effects the future holds. Nassim Taleb’s “Black Swan” covers this part wonderfully. Essentially when you buy a stock you have to have the conviction that all of the world is incorrect and you are seeing something that others don’t. Which even has a higher probably: 1) you and I are wrong in our analysis 2) the whole world is wrong and we found a true investment gem? I’d put my money on the first event.
Turning to the argument that many people sell low and buy high – I agree. Yet if you ever find some time please read Daniel Kahneman’s “Thinking Fast and Slow”. He proved that taking losses is twice is painful as taking gains. People actually cling to losing stocks longer than they should and sell winners earlier than they should.
Average CFA, These are some very thought provoking comments you have added. Thank you. I will have to check out both the books you mention here. I tend to agree with what you are saying and it is my biggest obstacle in deciding to sell and redeploy the funds in something undervalued. Fact is it’s just too damn hard to get it right and too damn easy to get it wrong. Still I’m curious as to what criteria would be needed to increase the likelihood of getting it right…
I’m nothing if not an optimist
Stoic,
Looking forward to your findings on this matter and the subsequent articles.
For me, personally, this is an evolving thought process.
As of now I will only sell if the following occurs:
1. A dividend cut is imminent or has already come to pass. I did this with my TEF sale.
2. The company’s fundamentals have changed. This can be wide-ranging and vary anywhere from the business model changing or becoming less relevant or growth prospects dimming significantly or cash flow problems.
3. The company’s stock becomes wildly overvalued. I made a mistake in selling my XOM holdings, as they were not wildly overvalued, but made a decision also based on my allocation to energy. This trigger also depends on the market as a whole. If you sell one stock, can you really find value elsewhere to the point that the taxes and commission fees are worth it?
4. I have a personal emergency and need a large amount of capital in a hurry. This one is probably fairly obvious.
The above triggers can be highly subjective. I am now to the point where I don’t really plan on selling holdings in the future unless my hand is forced (dividend cut or I need to raise cash due to an emergency). I don’t like to play the market game, and instead plan on holding all my positions indefinitely and sharing in those company’s profits.
Best wishes!
DM, Thanks for stopping by and sharing your thoughts. I agree with you on selling stocks when the fundamentals behind them have changed, like a dividend cut. What I’m curious about is if a portfolio could be enhanced by taking profits and rolling them back into other income stocks. It would seem that if this were practiced selectively over time the portfolio would be larger due to the use of the profits adding addtional shares of income producing stocks. The big unknown here is if an investor could take those profits and actually find somewhere else to put the money that would increase income and preserve capital. This is what I’m having a hard time with. Any thoughts???
I also don’t like to try and time the market. For one, I’m not very good at it. For two, I feel like the market is irrational, so it takes too much time and effort to do.
I’m definitely the buy and hold forever type of investor. I like to keep things as simple as possible – It’s just easier. I feel like if I invest in the best of the breed companies, then I shouldn’t have to sell. That is unless one of the following happen:
1) The dividend is cut or suspended
2) Fundamentals (cash flow problems, consistently missing earnings, increasing debt, mismanagement continually making bad news headlines, etc.)
3) Outdated products/technology; loss of marketplace dominance (Dell, HP, Kodak, Rim, etc.)
Other than that, I plan on holding on to the stocks I purchase. Even if I feel a stock is overvalued (KO), to me it is still worth holding b/c I still believe in the future outlook. None of the above have yet to occur, so I feel comfortable staying invested. Trying to time out of this position so that I can invest in another is again, attempting to time the market. It’s a gamble that may or may not pay off.
However, if I do feel the need to make more than just the dividend, I would consider writing calls and selling puts to collect a premium. Though I would probably lean towards selling puts since I prefer not to sell. This would alleviate any itch I have for trading.
Thanks for stopping by FI Fighter and sharing your thoughts with us. I like your approach and there is much to be said for keeping things consistent and simple. Makes it harder to lose money that way eh? 😉
I would love to know more about options trading. I may pick your brain on the subject from time to time.
I have sold holdings to buy something else with higher yields with mixed results.
1) A few months ago I sold part of a REIT (LTC) when I recognized it was overvalued. The price rose high enough to be the largest position in my portfolio, and I don’t want to rely that much on a REIT. So I sold it and bought a similar company in the same industry (SNH) with a better valuation and yield. This worked out well. Since that time LTC is -17% and SNH is -2%. I increased my income and preserved capital. If only I could be this smart every time 🙂
2) The other month I sold PSX at $40 and used it to partially fund a purchase of INTC. Since then PSX is up 16% and INTC is down a little bit. Didn’t work out so well, but my income did go up.
The goal of increasing my income was met both times. This shouldn’t be hard to do. Maintaining your capital might prove to be a bit more difficult, because timing the market is hard!
Oh and all this was within my ROTH so I didn’t care about taxes, only fees.
CI, Thanks for sharing these examples of acutal trades in your portfolio. As you said it would be great if we could be as smart/lucky as you were in example one every time we utilized this strategy. I don’t know if it is possible to do it consistently for any of us and that is my one BIG objection to this approach. Still, I want to know what criteria would make it possible to come closwer to example one trade on a consistent basis. I even think example two is not far off the mark I’m hoping to achieve. Short term price movements don’t mean a great deal to me unless they work in my favor when it comes to buying.
Yes, timing the market is very hard 😉
Earlier this year I wrote about some conditions for selling a stock:
http://dgmachine.blogspot.com/2012/03/conditions-for-selling-stock.html
1. The dividend is suspended, cut, or frozen
2. The company’s fundamentals are deteriorating
3. The company is changing through a merger, major acquisition, split, or spin-off
4. The stock has become extremely overvalued
5. Important information was overlooked when the stock was bought
6. A large capital loss can be realized to offset taxable income
#4 is a tough one and I’ll admit I don’t have a strict set of criteria for judging overvaluation.
As for the strategy of selling a stock with a low yield (due to high capital gains) and replacing it with a stock with a higher yield: It is a sensible strategy, but it depends strongly on the particular stocks involved in the switch and whether the portfolio will be stronger as a result. If the low-yielding stock is not overvalued, then I would likely be inclined to keep it.
I like this list DGM and think it is a sensible approach when evaluating the quality of stocks that make up a portfolio.
This is what I’m focusing on most. It is probably the Holy Grail of stock investing and I’m being foolish thinking it can be done.