You got to know when to hold ’em, know when to fold ’em,
Know when to walk away and know when to run.
You never count your money when you’re sittin’ at the table.
There’ll be time enough for countin’ when the dealin’s done.
Kenny Rogers makes it sound simple in “The Gambler,” but when it comes to “knowing when to fold ’em” in investing, determining when to sell a stock can be much more difficult than picking a stock to buy. There are many reasons for this; here are a few.
- Emotions. Despite their honest efforts to leave emotion out of investing, investors often find themselves selling too soon based on a knee-jerk reaction to bad news that doesn’t change the company’s long-term prospects — or refusing to sell due to an attachment to a stock despite a deterioration of its long-term outlook.
- Anchoring and other biases. As detailed in a series of articles by Fool contributor Brian Stoffel, investors can often be their own worst enemy by focusing on data points that shouldn’t factor in investment decisions. If a stock has dropped by 50% in the past year, many shareholders will be thinking, “The stock is so cheap now that it can’t drop any more,” and, “I’ll sell when it gets back to the price I paid.” Looking backward instead of forward can be a dangerous mistake for investors.
- Drawback of buy and hold. The benefits of a long-term buy-and-hold strategy have been widely popularized by investing greats like Warren Buffett and Benjamin Graham. Buy-and-hold investing has helped many investing greats achieve staggering success, and it spares average investors from many of the brokerage fees, capital-gains taxes, and other transaction fees that can erode their returns. While this strategy has proven successful countless times, investors’ efforts to stay true to this philosophy can keep them from selling when they should.
In short, it’s not easy to identify when it is time to sell a stock.
Focus on the investment thesis
Every investor has a slightly different take on what criteria drive the decision to sell a stock. While Warren Buffett has famously said that his “favorite holding period is forever,” there are certainly instances where selling a stock is necessary. Here are a few examples using stocks recently sold from my personal portfolio.
The investment thesis is broken. Every successful investor should develop a simple investment thesis prior to purchasing shares of a company. As more information becomes available over time, this thesis may prove to be broken as a result of unexpected changes in the competitive or macroeconomic environment, management failures, or simple investor error. One example of a broken thesis is an investment in Itron, Inc. (NASDAQ:ITRI) based on the company’s ability to take advantage of “inevitable trends” of rising demand for water and scarcity of energy resources. The thesis made sense initially, but it hasn’t turned out well thus far as the company bounces near five-year lows while the overall market has surged to all-time highs.
Competition and government budget tightening have prevented top- or bottom-line growth despite the ongoing long-term view that Itron, Inc. (NASDAQ:ITRI)’s smart-grid capabilities will be a part of the growing need for smart meters. To make matters worse, there is no known timeline for when to expect a return to the growth that the investment thesis was based upon. Potential doesn’t necessarily translate into investment success, as is clearly the case with Itron, Inc. (NASDAQ:ITRI).
Management integrity is questionable. There are few reasons to invest in a company at which there are questions regarding management’s integrity. There are too many good companies out there to justify the added risk that fraud or other unscrupulous acts will drag down the shares’ performance. This approach sounds easy enough in theory, but in an era where anonymous articles written by biased short-sellers can allege just about anything with a minimum amount of support, it can be difficult to separate short attacks from serious concerns about management integrity.
