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Know When to Sell Stock
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Ideally, we'd all hold our investments forever, but the reality is that few companies are worth holding for decades at a stretch—and few investors are savvy enough to buy only those companies. Knowing when it's appropriate to bail out of a stock is at least as important as knowing when to buy one, yet we often sell our winners too early and hang on to our losers for too long.

Growth of $10,000 Investment (After Taxes, Commissions Included)

The key is to constantly monitor the companies you own, rather than the stocks you. own. It's far better to spend some time keeping up on the news surrounding your companies and the industries in "which they function than it is to look at the stock price 2O times a day.

Before I discuss when you should sell stock, I ought to point out when you shouldn't sell.

The Stock Has Dropped

By themselves, share-price movements convey no useful information, especially because prices can move in all sorts of directions in the short term for completely unfathomable reasons. The long-run performance of stocks is largely based on the expected future cash flows of the companies attached to them—it has very little to do "with "what the stock did over the past week or month.

Always keep in mind that it doesn't matter "what a stock has done since you bought it. There's nothing you can do to change the past, and the market cares not one whit whether you've made or lost money on the stock. Other market participants—the folks setting the price of the stock—are looking to the future, and that's exactly what you should do when you're deciding whether to sell stock.

The Stock Has Skyrocketed

Again, it matters little how those stocks have done in the past—what's important is how you expect the company to do in the future. There's not a priori reason for stocks that are up substantially to drop, just as there's no reason for stocks that have tanked to "have to come back eventually." Most of us would be better investors if we could just block out all those graphs of past stock performance because they convey no useful information about the future.

So when should you sell? Run through these five questions whenever you think about selling a stock, and you'll be in good shape.

Did You Make a Mistake?

Did you miss something when you first evaluated the company? Perhaps you thought management would be able to pull off a turnaround, but the task turned out to be bigger than you (and they) thought. Or maybe you underestimated the strength of a company's competition or overestimated its ability to find new growth opportunities. No matter what the flub, it's rarely "worth holding on to a stock that you bought for a reason that's no longer valid. If your initial analysis was wrong, cut your losses, take the tax break, and move on.

Have the Fundamentals Deteriorated?

After several years of success, that raging growth company you bought has started to slow down. Cash is piling up as the company has a tougher time finding profitable, new investment opportunities, and competition is eating away at the company's margins. Sounds like it's time to reassess the company's future prospects. If they're substantially worse than they used to be, it's time to sell.

Has the Stock Risen Too Far above Its Intrinsic Value?

Let's face it: The market sometimes wakes up in an awfully good mood and

offers to pay you a price far in excess of what your investment is really worth. There's no reason not to take advantage of other investors' good nature. Ask yourself how much more the market is willing to pay you than your estimate of the value of the stock and how likely it is that your estimate of its value could go up over time. You don't want to sell wonderful companies just be­cause they get a little pricey—you'd incur capital gains and wouldn't be taking advantage of compounding. But even the greatest companies should be sold when their shares sell at egregious values.

Is There Something Better You Can Do with the Money?

As an investor, you should always be seeking to allocate your money to the assets that are likely to generate the highest return relative to their risk. There's no shame in selling a somewhat undervalued investment—even one on which you've lost money—to free up funds to buy a stock with better prospects.

I did this myself in early 2003 when I noticed that Home Depot was looking awfully cheap. The stock had been sliding for almost three years, and I thought it was "worth about JO percent more than the market price at the time. I didn't have much cash in my account, so I had to sell something if I wanted to buy Home Depot. After reviewing the stocks I owned, I sold some shares of Citigroup, even though they were trading stock for about 15 percent less than what I paid for them. Why? Because my initial assessment of Citigroup's value had been too optimistic, and I didn't think the shares were much of a bargain any more. So, I sold a fairly valued stock to purchase one that I thought was very undervalued.

What about my small loss on the Cltl stock? That was water under the bridge and couldn't be changed. What mattered was that I had the opportunity to move funds from an investment with a very modest expected return to one with a fairly high expected return—and that was a solid reason to sell.

Do You Have Too Much Money in One Stock?

This is the best reason of all to sell because it means you did something right and picked a "winner. The key is to not let greed get in the way of smart stock portfolio management. If an investment is more than 10 percent to 15 percent of your portfolio, it's time to think long and hard about trimming it down no matter how solid the company's prospects may be. (These percentages are a rough guide—you might be comfortable with more money in a single stock, or you might want to be more diversified.) It simply doesn't make sense to have too many of your eggs in one basket.

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