When to sell?
Posted on 10. Jan, 2011 by TheFreeInvestor in Investing Philosophy
As I invest for long run, I had very little realized gain/loss in 2010. So, at the end of the year, I didn’t have to do many tax loss related selling. However, in the new year, I am critically reviewing my holdings to see whether each of my investment thesis are playing out as expected.
When to sell decision is as important, if not more, as the decision about when and what to buy. But, long term investors are more likely to talk candidly and confidently about their stock selection process than about their process for when to sell. You can count me in one of those people who is wrestling with this issue for many years now. There are so many views out there in the market – “cut your losses”, “trim your winners”, “take some money off the table” and the list goes on. Here are a few criteria that I use to decide if to sell a position. (this excludes need-based selling that I do if I need the money and tax planning related sellings).
1. Original investment thesis was wrong or did not play out
Most of the selling I did early this year can be attributed to this criteria. This happens a lot in turnaround situations where you are betting that the new management will turnaround the company. As I don’t have direct access to management team most of the time, I have to rely on other people’s opinion of the new management. Sometime it works out, but more often for me turnaround situations don’t work out. In my recent sells, Pacific Sunwear (PSUN) and Princeton Review (REVU) were both bets on turnarounds that didn’t happen. After watching these stocks continue to be in red for more than 2-3 years, I have lost faith that these will be turning around anytime soon. So, I realized my losses and moving on to better opportunities. I use this criteria only after waiting for at least 2-3 years as sometimes it takes a long time for an investment thesis to play out.
2. Investment thesis has changed (for worse)
Change in investment thesis is hard to detect. In many cases, it is slow and gradual drift than a sudden change of course. In some other cases, it is event driven change in the business environment. Cemex (CX) was a strong cement manufacturer in the pre-2008 era. But, just before the housing bubble bust, they acquired Rinker at an expensive (in hindsight) valuation. It doesn’t look like CX will get over that hangover anytime soon. So, I have sold my CX position at a loss.
3. Stock has become excessively overvalued
This one is a tricky. I hate to sell based on valuations because I am never that confident on my ability to do precise valuation to say that the stock is definitely overvalued. In addition, day to day valuation matters a lot less if you are owning the stock for a long haul, e.g., five years, ten years or more. In short run, the stock might get overvalued. But, if we sell solely based on that we will lose the potential to own any company that has potential to be a Microsoft (MSFT) or Apple (AAPL) or Wal-Mart (WMT). Netflix (NFLX) is a 8-9 bagger for me now. If I sold it after it doubled or tripled based on just valuation, I would never had the opportunity to see 800% gain. So, when it comes to selling based on valuation, I am very trigger shy.
But, I did sell about 20% of my Netflix holdings because, a) it was getting too big a position in my portfolio, b) the future for Netflix looks much more competitive than the past. In other words, I don’t have as much confidence in their future business prospects as I had four year ago. Now, with more than 100% realized gain on my original investment, I am comfortable holding the rest of my Netflix shares for a long time or till the time the story starts to change.
Finally, there is “sleep-test” – investing in stocks has its share of uncertainties. But, if any of the stock positions are making you lose your sleep then it is time to sell or at least trim that position to a level that makes you sleep peacefully at night !
[Photo credit: Diana Parkhouse]
[Disclosure: As of the publication of this post, I hold long position in NFLX. Please read the disclaimer statements on this site.]
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