Get Smart About Selling Your Stocks

By Dan Caplinger | More Articles
September 13, 2010 | Comments (1) 

 

If you want to be a successful investor, it's not enough just to make smart stock picks. You also need to figure out when the right time to sell those picks is. If you don't force your investments to justify their place in your portfolio every day, then you run the risk of losing every penny of the hard-earned profits that smart pick made for you.

Learning the hard way
No matter how much you love a stock, there are times when you can save a lot of money by letting it go. For instance, all five of the following companies share something in common:

Company	Gain	Loss
YRC Worldwide (Nasdaq: YRCW)	295% (March 2001 to March 2005)	(99.7%) (March 2005 to June 2010)
Ford Motor (NYSE: F)	117% (March 2003 to June 2004)	(87%) (June 2004 to January 2009)
Sirius XM Radio (Nasdaq: SIRI)	208% (Aug. 2004 to Nov. 2005)	(98%) (November 2005 to December 2008)
Mosaic (NYSE: MOS)	626% (January 2007 to June 2008)	(79%) (June 2008 to November 2008)
Southern Copper (NYSE: SCCO)	709% (June 2005 to October 2007)	(68%) (October 2007 to February 2009)

Source: Yahoo! Finance.

With each of them, you could have made a boatload of money if you'd bought it at the right time. And with each of them, if you didn't see the warning signs ahead of time, you would have lost most or all of the gains that took years to earn.

In particular, bankruptcy threats hit Ford and Sirius during the financial crisis to stop their recoveries in their tracks at least temporarily, and similar problems still plague YRC Worldwide and the outcome remains uncertain. The boom in commodities helped fertilizer maker Mosaic and the Latin America-focused copper company Southern Copper reach big peaks, until the bottom fell out of the commodity markets.

More than just timing
I'll admit that it's easy to throw out these examples in hindsight as stocks you should have avoided once they started going down. But if perfect timing is impossible, then how can you expect to milk every penny of potential profit while getting out at the right minute to avoid losing it?

The answer is that you won't always sell at exactly the right time. But as long as you sell in time to save yourself from potential disaster, then the fact that you leave some money on the table is inconsequential. Here are some things to look out for:

• Shareholders vs. management. When C-level executives seem to be more concerned about golden parachutes and stock option paydays than investors, you need to look for the exits. Sometimes you'll miss out on gains even in spite of executive siphoning of profits, but often you'll get out at what turns out to be the perfect time.
• A disappearing moat. Competitive advantages aren't always permanent. If a company can't defend its territory, the loss of its competitive edge can be devastating to share values.
• Cyclical stocks. It's particularly important to understand when a high-flyer is simply at the top of its ordinary business cycle. For instance, right now Annaly Capital Management (NYSE: NLY) and MFA Financial (NYSE: MFA) are benefiting from low interest rates and relatively high rate spreads. What investors have to look at is what will happen if those conditions change, as they eventually will. If a stock is truly cyclical, then selling at highs with the expectation of picking up shares much cheaper down the road can be the right move.

In addition, you should look to see if the reasons you bought the stock in the first place are still valid. Even if a company has enjoyed big growth, it may have done so for the wrong reasons, in your view. If you can identify unsustainable trends, you'll escape before the rest of the market figures out the disparity.

Stay aware
You won't always time your exit from a troublesome stock perfectly. More important than your actual timing, however, is the fact that you need to go through the thought process of considering selling your investments -- and it should be a regular part of your overall investing strategy. You should never give an investment a free pass, especially if it has created losses for you recently. If you stay vigilant, you'll sometimes succeed in jettisoning a time bomb in your portfolio before it goes off and causes real damage.

Selling stocks should probably be the last thing on your mind right now. Morgan Housel explains why history says now's a great time to buy stocks.


http://www.fool.com/retirement/general/2010/09/13/get-smart-about-selling-your-stocks.aspx