Successful stock investing requires you to buy and sell. Knowing when to cut ties with a stock is not easy. We give you five good reasons to unload your shares.
1) Fundamentals have changed
One question to ask is whether a company's fundamentals have deteriorated since you purchased the stock. Even companies that have performed superbly for years can sometimes lose their way. If some of the shining prospects that originally attracted you to a firm have dimmed, it could be time to reassess your outlook for the company.
One good place to start looking would be the financial statements. Perhaps once-hefty profit margins have steadily inched downward of late as more aggressive competitors have come on the scene. Or, maybe what looked like a smart acquisition two years ago has degenerated into a morass of asbestos litigation. Or, market share may have fallen off as the company struggled to pump out innovative new products.
When re-evaluating the company, distinguish between changes that are temporary blips, such as seasonal shifts or a slightly delayed new product launch, and those shifts with implications for the firm's future, such as an increasingly uncompetitive cost structure. If you see that the fundamentals are indeed declining and seem rooted in changes that are longer-term in nature, it may be time to consider selling the stock.
2) You made a mistake
Despite all the careful research we do, you will not have a 100% success rate. Even professionals often get it wrong. Some renowned investors are happy if they can get 70% of their stock picks right. That means that even the world's greatest investors get it wrong at least 30% of the time. All that matters is having more right picks than wrong ones.
Sometimes you might uncover some new information about the firm or management after you've already bought the stock. Maybe you've learned that the company has made liberal use of "special-purpose vehicles" to hide debt. Or, perhaps the new CEO you thought would lead the firm out of its doldrums has become embroiled in a culture clash with the employees. In any case, it's usually not worth keeping a stock when you find the original rationale for buying it no longer holds true. It's better to cut your losses and move on. This is often easier said than done because human nature makes it difficult to admit we're wrong.
3) Price has shot up
Over time, you may find that some of your stocks have zoomed up in value and now make up an outsized portion of your portfolio. If any single stock makes up more than 10% of your portfolio, you should think carefully about how much risk you're taking on. Even if you believe the company's prospects are still favorable, it's not a bad idea to think about taking some money off the table to rebalance your portfolio and lower your risk. Keep in mind that different sectors, industries, and companies will perform better under different conditions and at different times. So, even if an outsized holding in your portfolio is performing well now, it's unlikely that stock will always deliver positive results.
4) Reaching intrinsic value
Though we like to keep our eye on how much we believe a firm is really worth, the market will often give a company more credit than it deserves, reflected in a stock price that's above the firm's intrinsic value. If you find one of your stocks in this situation, you might well think about locking in gains by selling some shares, especially if the company has a narrow or no economic moat.
Wide-moat stocks, on the other hand, warrant a different approach. Companies with strong, sustainable competitive advantages are likely to create value over time. As a result, these firms often see their fair value increase over the long term. We're generally reluctant sell wide-moat stocks, even if they pass through periodic phases of modest overpricing. Because wide-moat stocks seldom sell far below fair value, it may be quite difficult to buy them back cheaply once you've sold.
5) Portfolio needs rebalancing
It could be as simple as your portfolio needing to be rebalanced. If you are in the throes of a bull market, your equity exposure may be way off mark. It would make sense to offload some stocks to bring the balance back in. You need not “sell”, you could “reduce”. In other words, you don’t have to completely exit a stock but just decrease its position in your portfolio.
The squirrel strategy is one way to reduce your exposure either to the share market generally or to more speculative stocks if the outlook is a little cloudy, or simply if they've had a great run.
The "squirrel" constantly takes at least half the profits out of the speculative market and re-invests into something of long-term value. If times are booming, that might be cash for safety.
Squirrels are able to put enough away for a rainy day, without forgetting to enjoy the sunshine while it lasts!
