Determining when you should sell a stock may seem tricky, but it is actually really simple.
Warren Buffett says that the ideal investment is one that you can hold onto forever, growing your money for as long as you own it.
However, Buffett and every other successful investor also know that there are times when selling a stock is the best path forward. So, the question is when should you sell a stock?
When is it the right time to sell a stock?
If you’ve done your homework, you’ve bought a wonderful company at a great price, so why sell it? Just like figuring out when to purchase a stock, figuring out when to sell one can be tricky.
You definitely don’t want to regret the feeling that you sold something too late or too soon.
So, let’s talk about the circumstances where you might want to sell a stock. These are not only backed by me, but by Warren Buffett and almost every other “Rule #1 Value Type” investor out there.
1. Sell a Stock When the Fundamentals of the Company have Changed
All companies change over time – sometimes for the better and sometimes for the worse. New management sometimes takes over, new competition comes onto the market, and, sometimes, the very fundamentals of the company itself may change.
This type of change can come in many forms – a new CEO, new laws or regulations that impact the company, or a change in the core mission of the business.
If the company you now own is no longer the same company that you first invested in and you no longer have faith in its new direction, it’s a good time to sell your stock.
2. Sell a Stock When the Price of the Company has Reached its Intrinsic Value
As Rule #1 investors, we try to purchase companies at a discount to their true value. Thankfully, various events in the market can often drive the price of a company down to 50% or more off of its true value, creating an excellent buying opportunity.
What happens, though, when the price of these companies that we invest in goes up to a point that is equal with the intrinsic value of the company? When this happens, it might be a good time to exit your position.
There may be times when the price of a company continues to rise even after it has surpassed the company’s intrinsic value. Selling a company that is still increasing in price may seem like leaving money on the table.
By the same token, though, holding on to a company that is overvalued is a risk. In these situations, it’s typically best to sell your stock and be happy with the profits you’ve made no matter what the stock does in the future. Heck, you just made 50% returns. Be happy.
3. Sell a Stock When You Have a Better Opportunity
While it’s always ideal to have cash set aside for use in case a great investment opportunity comes up, there may be times when you want to invest more than you have available in cash.
In these situations, it’s perfectly okay to sell a stock in order to free up capital even if the company has not fundamentally changed and even if the price of the company has not reached its intrinsic value.
With that said, you do have to be careful that you are not caught up in the cycle of constantly searching for greener grass.
If you find a stock that really is better than the stock you’re considering selling and you don’t have enough money in cash to invest as much as you would like to, selling stock to free up capital is a perfectly viable option.
So, when is the WRONG time to sell a stock?
There are a few times when it is a good idea to sell a stock, and many more times when selling a stock is the wrong thing to do. By far, the worst reason for selling a stock is a price drop.
However, price drops are the number one factor that leads many investors to sell. When the price of a stock starts going down, many investors become afraid and decide to cut their losses.
If you have invested in a wonderful company that has not yet reached its true value, though, selling that company just because of a temporary dip in price is a very short-sighted decision and a surefire way to guarantee that you never make money in the stock market.
If your reason for wanting to sell a wonderful company is driven mostly by an emotion such as fear, you need to take a step back and logically determine whether or not selling the stock is really the best path forward.
Ask yourself why you’re not confident in your initial decision to invest. Have you really done your homework? In most of these cases, a little logic and a lot of patience is all that is required to avoid selling when you shouldn’t.
Now I’d love to hear from you. Have you ever sold a stock when you shouldn’t have? Let us know in the comment below.
Phil Town is an investment advisor, hedge fund manager, 3x NY Times Best-Selling Author, ex-Grand Canyon river guide, and former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo, and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence.