Much has been written about how to evaluate stocks in order to buy them, but less has been written about what you need to do before you decide to sell your investments. To every investing equation there are two sides - the buying side and the selling side... or the opening transaction and the closing transaction.
So, today, I want to give you a shortlist of tips on how to make good selling decisions, so I referred to an article recently titled - "When Do I Sell Stocks?" by James deMasi on a website called gurufocus.com
We all know the best time to buy a stock is when its price is attractive relative to its future earnings and growth potential, a price that delivers true value with significant growth potential. But selling a stock isn't an easy decision because you fundamentally have to ask yourself - do I sell this now or do I stay invested for longer?
And I think many of you might actually have experienced this firsthand had you invested, for example, in companies like Google at its IPO or Apple over the years. Perhaps you bought shares of Google at $100 and delightfully watched them double, triple, quadruple and so on, yet at every $100 threshold you were likely unsure whether to hold or sell. I know from speaking with many of my friends they also faced this dilemma with shares of Apple.
Here's another common scenario. Say you buy a stock and it shoots up 60% in just three months, way sooner than you expected and perhaps with a momentum that you might feel is unsustainable. What then? Do you take your gains now and perhaps buy the stock back again if it drops to where you think it's become a value stock again-or do you wait until it reaches your target sell price and then offload?
So How Should Investors Make Their Selling Decisions?
The fundamental question you've got to ask yourself is this: "does selling make sense given everything I know about this company?" That is the single most essential question that you have to ask yourself before you push the sell button. Sometimes you might just find that you actually do not know enough about the company and need to do more research - and that's never a bad thing because it'll only make you better informed on the insides of a company that you're invested in.
The article on gurufocus.com, gives us an example of the "should I sell?" decisions that Mark Zuckerberg - the founder of Facebook - had to make as he was growing his company. In 2004, Zuckerberg received a $10 million offer to sell that he apparently did not consider for even a minute! Then, just a year later - in 2005 - MTV made a $75 million offer for Facebook which he too rejected. Then, another year later, he received not one but three offers - from MTV, Yahoo and AOL - all above $1 billion... and guess what; he said "no, I think my company's worth a lot more. I may never have an idea as good as this again, so I'm not interested in selling."
In confidently refusing these offers, Zuckerberg was sticking to his circle of competence because no one knew Facebook better than him, and that clarity of its business model and true worth gave him the confidence to reject a $1.5 billion offer - that's pretty incredible, when you're in your mid-20s and someone dangles over a billion bucks! Saying no takes guts and reflects an unshakeable faith in yourself and your company. And his refusal to sell has of course worked out really well for him because Facebook is now worth over $65 billion and Mark's interest alone ---has a net worth of around $10 billion.
So if you do not fully understand the business that you're invested in, you'll depend on the market to give you a sense of its value, and a market of buyers will always want to undercut you on price - remember, everyone's looking for a deal.
So when should Zuckerberg sell? If he listens to Warren Buffett, the best time to sell is never. As Buffett puts it, only buy something that you'd be perfectly happy to hold should the market shut down for 10 years. And Buffett has that confidence because he makes sure he fully understands the business and long-term economics of a company he invests in.
Much like Buffett, when you're doing your research on shares you might want to buy, imagine you're buying a private company that will not go public for at least five years or more... and then ask yourself, what do I need to know before I lock myself into the stock for five years? You'd want to know who runs the business, what their past experience and successes are, what their weaknesses are, what the company's business model is, how well it's competitively positioned within its industry, its strengths / weaknesses / opportunities / threats, its supply chain, the profile of its customers and so on.
But let's also be real, not everyone has the background or the mental makeup of a Warren Buffett. Moreover, businesses often change over time--- and long-term ownership may not always be practical, especially in industries such as technology where obsolescence and growth go hand in hand at a very rapid pace.
Another investing legend Philip Fisher, outlined the following three conditions on when you should sell:
1. When you realize that your initial analysis was materially wrong.
2. When shares no longer qualify as a good investment because of a material deterioration in the company such as management complacency, exhausted growth opportunities, product obsolescence and so.
3. When you clearly have a better opportunity for higher returns. --- But on this last point, ---you must be absolutely sure of your analysis to justify a switch even after factoring in the possibility of your analysis being 20% to 30% off the mark.
So be thorough in your analysis and that will give you the confidence and the insights on when to hold and when to sell. And remember... it takes many, many years for those great investments to evolve, so when you do buy a company, Make sure to stay invested for the long run.
Steve Pomeranz is a Managing Director for United Capital Financial Advisers, LLC, "United Capital", and owner of On The Money. On The Money is not affiliated with United Capital.