By the same token, if you sell too quickly, you can miss out on huge multi-baggers such as Wal-Mart, and Coke in the early days.
Really, you want the best of both worlds – a strategy that allows you to both harvest profits and achieve huge returns. That means thinking carefully about both your sell criteria and your hold criteria. These criteria are different for every investor and every portfolio, but I’ve found the following works well for me.
Really, you want the best of both worlds -- a strategy that allows you to both harvest profits and achieve huge returns. That means thinking carefully about both your sell criteria and your hold criteria. These criteria are different for every investor and every portfolio, but I've found the following works well for me.
1) Hold when the price changes
Price changes, up or down, don’t change a company’s fundamentals. If you sell simply because the stock has made you 50% in a short time, you’re potentially throwing away a much bigger long-term profit. If the price goes down on no news, the company becomes more attractive, not less. So it doesn’t make sense to sell simply based on price changes.
2) Hold when temporary bad news comes
Adverse news will come to every stock, sooner or later. The company will miss estimates by pennies but fall by dollars. In itself, this isn’t a reason to sell. If the factors are temporary, and, in the long term the business is still strong, it still makes sense to hold, or even buy.
3) Sell when the stock is way overvalued
If a great stock is fairly valued, then it makes no sense to sell it, generally. You’ll likely know that company better than any new company you add to your portfolio, and it’s hard to find great companies at cheap prices, so you should naturally be reluctant to give up the ones you have on hand. But if the company becomes extremely overpriced, then it’s time to jettison it – it will be unlikely to earn spectacular future returns.
A couple years ago, Warren Buffett noted he made a mistake holding on to Coca Cola when it was priced at a high of 60 times earnings or more in the late 1990’s. Though Coke is a great business, it was way too expensive back then, and subsequently, its stock has had terrible returns.
4) Sell when the business fundamentals changes
If you’re buying a great business, and suddenly you notice that the business isn’t actually that great any more, it makes sense to sell. The key decision point is whether the changes are temporary bumps or the business competitive edge has eroded permanently. I suspect like in Berkshire Hathaway case, they sold H&R Block recently for such a reason.
The customer base and the margins of its core tax-return business are slowly being eroded by competition from tax software such as Intuit’s TurboTax. H&R has responded with its own tax software, but it’s clear that technology is changing the tax business and weakening its competitive position.
5) Sell when there’s a better stock to buy
If you’re short on money but see an incredibly compelling stock that you absolutely must own, then by all means sell a less attractive stock to raise the funds. But before you make the move, make sure you take into account the transaction costs and taxes. Often it won’t make sense to sell a company in which you have large returns, pay the taxes, and put the proceeds into a marginally more attractive stock. So if you have to switch, ensure the next pick has a much higher margin of return than what you have on hand.