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When Do I Sell Stocks?

January 09, 2013
You constantly hear about which stocks to buy and when to buy and why you should buy. But to any equation, there are two sides.

For every stock you buy, you have to sell it sooner or later.

Here is a list of previous articles to answer the question, “when do I sell stocks?”.

Let’s revisit some of these topics above from a different angle with a guest post by James DeMasi of Seraphin Group in response to a question I asked on the OSV facebook page.

“Name one lesson you learned in 2012 and how you are going to be a better investor for it in 2013?”

When Do I Sell Stocks?: Drawing Wisdom from Buffett to Zuckerberg

when-do-i-sell.jpgEvery investor knows when to buy a stock. You buy when you believe that the stock is attractively priced relative to the price you believe is its true value.

On the other hand, selling can be a little trickier. Say you buy ABC stock for $25. You believe it will be worth $50 or more in three years. Three months after your initial purchase the stock rallies to $40. This isn’t uncommon and it makes many investors very nervous as they wonder, “What should I do now?”

A Common Scenario

The stock has not hit your intrinsic value target, but you’re holding a 60% gain only 3 months into your investment.

This is way sooner than you had expected and this kind of momentum could very well be unsustainable. You might consider taking the gain now and then buying it back when the stock dips, but how big of a dip is big enough?

Will you know? Is $37 acceptable? Should you wait for it to go lower than that? What if ABC never reaches your price point to rebuy? Could you ever possibly buy back in with a comfortable mindset?

As an investor, you’ve probably found yourself in this exact position more than once, so let’s talk about the solution. Forget the market for a second.

The only question to ask yourself here is, “Does selling make sense given everything I know about this company?”

Being able to answer this single question is essential and could quite possibly be difficult, because you might find that you don’t know as much about the company as you should.

Lessons on Conviction from Mark Zuckerbeg

zuckerberg-selling-stocks.jpgLet’s turn to Mark Zuckerberg to illustrate just how powerful this one question can be.

In 2004, Friendster and an unnamed New York financier each made $10 million offers to buy Facebook. David Kirkpatrick wrote in The Facebook Effect that Zuckerberg, “didn’t for a minute think seriously about accepting,” these offers.

In 2005, Viacom’s MTV offered $75 million, which was also rejected.

In 2006, MTV, Yahoo, and AOL all made $1 billion-plus offers and were turned away.

Michael Wolf, CEO of MTV Networks told Bloomberg that Zuckerberg’s response to his $1.5 Billion offer was, “I think it’s worth a lot more… I may never have an idea as good as this so I’m not that interested in selling.”

Stick to Your Circle of Competence

circle-of-competence.jpgAt this point you may be beginning to understand why Buffett recommends that you stick to your circle of competence.

No one will ever know more about Facebook than its creator, Mark Zuckerberg. That level of in-depth knowledge brings the clarity and confidence that one would need in order to reject a $1.5 billion offer. He knew what he had and, as he said, he believed it was worth more.

Lo and behold the company now has a $60 billion market cap. If you don’t fully understand the business that you’re invested in then you will be reliant on the market to tell you what it’s worth, because, frankly, you don’t honestly know. Being in that type of position never allows for good decision making.

So when will Zuckerberg sell? Never. Buffett has also said that, “The best time to sell is never.” He went on to say, “Only buy something that you’d be perfectly happy to hold if the market shuts down for ten years.” Buffett is able to find companies that are worth holding onto indefinitely, because he makes sure to fully understand those businesses. This allows him to grasp the company’s long-term economics.

When you’re researching a possible investment then imagine that you are buying into a private company that will not IPO for at least 5 or more years. What would you want to know about that company before locking yourself into it? You’d probably want to know who the management are, what their qualifications are, what their business model is, what their competitive position is within their industry, what their prospects are, what their strengths, weaknesses, opportunities, and threats are, who their suppliers are, who are their customers are, and the list goes on.

But.. You are Not Buffett

Unfortunately, we cannot all be oracles like Buffet, and we may never know a company as well as its founder. Besides, businesses can and do change over time. As such, an infinite holding period may be more of a dream than a practical reality for most companies, especially as industries evolve at an ever more rapid rate. Therefore, we’ll conclude with the lessons of another great investor, Phil Fisher.

Philip Fisher’s Timeless Advice

In Fisher’s book, Common Stocks and Uncommon Profits, he advised that the right answer to the question “when do I sell stocks?” is when one or more of the following three conditions are met:

  1. When you realize that your analysis was materially wrong.
  2. When, due to the passage of time, the stock no longer qualifies as suitable investment according to his 15 scuttlebutt investment checklist. The most common reasons are management deterioration, managerial smugness, complacency, and exhausted growth possibilities.
  3. When there is a better opportunity, BUT you must be absolutely 100% sure of your analysis. Having held your first stock for some time, you know everything there is to know about that company. That is almost never the case with a new investment. Therefore, your analysis must be completely sound and the difference in return must be substantial enough to justify a switch even after discounting the possibility of not being perfectly correct.
How would Fisher answer the original question about what to do with our $25 stock that rocketed to $40? I believe he would hold onto it. He said that selling in that position will make it too difficult to ever get back into it. Besides, if the company is truly innovative then you never know what else the future may hold.

In conclusion, legendary investor Joel Greenblatt said it best.

“Ideally, your decisions to buy or sell stocks should be based solely on the investment merits.”

Of course, you have to be brutally honest with yourself and your analysis. If after all that, you are sure that you own a great company that you understand and feel confident in then be like Zuckerberg and don’t settle. Remember, it takes time for those 3, 5, or 10+ baggers to evolve and for wealth to be created. Happy investing and may good fortune be forever in your favor.

About the author:

James DeMasi
I began investing when I was thirteen years old. Although I studied finance throughout college and graduate school, I feel that nothing beats real, practical experience. When it comes down to it, there's nothing else I'd rather be doing than managing investment portfolios for myself and others.

Visit James DeMasi's Website


Rating: 4.2/5 (19 votes)

Comments

skyaboveyou
Skyaboveyou - 1 year ago
This is the article I was needing to read. Thank you... I find selling way too early to be my biggest investment problem... using Fisher points:

- I've had to deal with the point 1 on my first year of investing, 2011, I did plenty of those... fortunately while the portuguese main index (I only invested in Portugal until december 2012... sticking to what I know and is near) dived I could still stay roughtly flat with those errors... I think I was forced to lean that one rather quickly

-I believe I had one of those on point 2... I tend to classify it as an error on the initial analysis but the truth is that things deteriorated a lot due to actions of the management I didn't expect... sold out and never going back since I no longer trust the management... however it took me too long to react so I'm not sure that I've learned this one yet

-point 3 is my problem... I have sold because I've found other opportunities but in most cases I wasn't 100% sure I was doing the right thing (which has cost me a lot... I still did over 20% pre tax last year while the portuguese index went up 3% plus dividends but yet... it cost me a lot... only in the last month it has cost me an 8% pre tax extra profit)...

I believe this is the first article I read from you.. so here goes a big THANK YOU and I hope to see more articles about the same because I think that more articles about selling are missing in this site

paulwitt
Paulwitt premium member - 1 year ago
Another way to do it (I found out the hard way). If you have a big win sell half and let the other half ride.

I had call options that went up 12X with 6 months to go. The greed factor kicked in and needless to say the options expired worthless. I chalk this one up to experience.

Jae Jun
Jae Jun - 1 year ago
@paulwitt

Ouch I feel your pain. Hopefully things like that you only experience once.
jdemasi
Jdemasi - 1 year ago
@Sky - I appreciate your kind and encouraging comments. Selling too early used to be a problem of mine as well, but once you get it under control then you'll see that what you already suspect is true. You can make A LOT more money. It sounds like you're doing very well already. Keep it up and never stop learning! Maybe try using a checklist to help keep your decisions focused and your mind at ease.

@Paul - I traded options for about 5 years. Let me tell you, going back to investing in stocks is so much easier after all that time in options. This article doesn't exactly apply to options because options have a deadline, so timing is is very important, as you know. That's why I would always buy LEAPS whenever it made sense in terms of price and potential. It makes the timing part a little easier. I actually just purchased warrants for the first time today. They don't expire for 6 - 8 years, so I feel very comfortable.
paulwitt
Paulwitt premium member - 1 year ago
Hello James,

Thanks for the article about the important topic of when to sell (if ever).

I must say I don't trade options. I bought leaps on Leucadia and the leaps went up 12X when LUK was at $35. Subsequently LUK dropped down to $21 6 months later and expired worthless. I only bought the leaps as a stock replacement for LUK. Leucadia was a core holding of mine at that time.



jdemasi
Jdemasi - 1 year ago
Wow, that's rough. It's definitely important to keep greed under control, but sometimes it's hard to tell if you're being greedy or not. Again, I guess it comes down to investment merits. Still, losing out on a 12x gain is rough no matter how you look at it. On the plus side, even holding a gain that large is better than most ever see, so at least it's encouraging to know you've got that potential to identify a big mover. Keep at it! There were two times in my life that I questioned whether or not I wanted to keep going on this path, and ultimately I'm very happy that I stayed with it. It's a constant learning process.

If you haven't already been, then check out Jae's site, Old School Value. He's the other guy that commented here. I use his spreadsheets for quick valuations, though I did modify them a little, and then dig deeper if something looks interesting. If nothing else, it saves a lot of time.
paulwitt
Paulwitt premium member - 1 year ago
I'm not bitter about it because I only had a small position (I strongly believe in Warren Buffett's first 2 rules). The benefit I got out of it, besides experience, is that I bought one and a half years of time at low cost. I was able to do other things with my money because my core position was covered.

* I'm not giving up, I kind of enjoy investing more and more (I too have read all the great books out there)

Thanks for the words of encouragement!

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