As an investor who loves to simply buy, hold and collect returns
from myinvestments , I usually hate the idea of having to sell one
of thestocks in my portfolio.
After all, I'd like to think that I invested in good companies
that didn't ever need to be sold.
But sometimes, even stocks that have delivered years of solid
returns lose their stride. Other times, a good company may become
mediocre. And then there are times when you discover you chose a
bomb of astock instead of a treasure.
Meanwhile, dozens of other potentially great stocks await that
could make yourmoney grow much faster -- so why not just dump the
stock that's not performing?
Because selling for the wrong reasons can be a costly mistake.
It's much easier to buy a stock than to know when you should sell
Many investors are reactive and sell at the same time everyone
else does -- when they're fearful. But your emotions aren't the
best guide for making critical financial decisions. Look at how
investors have reacted to stockmarket downturns in the past five
As you can see, investors often react and sell after it's too
late. Other times, they hold on and keep losing money on a soured
stock. That's why it's important to be proactive, watching the
finances and moves of the company behind the stock you own, so then
you can see the warning signs before your stock falls (or in some
cases, plunges further than it has already).
While it's generally a good idea for most investors to sell
sparingly, here are some emotion-free signs that it's finally time
to sell a stock:
Warning Sign #1: Your stock has a shockingly
highprice-to-earnings ratio (P/E ).
While you may have enjoyed healthy gains from a stock you've held
onto for years, keep an eye on itsprice-to-earnings ratio (P/E) ,
which essentially compares the company's most recentearnings to its
stock price. Just as a relatively low P/E can signal that a stock
is a bargain, a relatively high P/E can indicate that a stock is
overpriced and ready for a plunge.
Case in point: From 1990 to the end of 1999,
Microsoft's (Nasdaq: MSFT)
stock skyrocketed more than 15,600%. However, its P/E showed the
stock had climbed well into overpriced territory, trading at a
price that was 84 times what it was earning per share. Once
investors realized the stock wasovervalued , many dumped the stock
and Microsoftshares lost nearly two-thirds (63%) of their value
during the year 2000.
Stay alert: While a high P/E doesn't always mean a stock is
overvalued (growth stocks sometimes have much higher P/E ratios),
you may want to investigate further if your stock has a P/E
significantly higher than its industry peers' or the overall
market's P/E (historically it's been between 14 and 17). You can
compare a company's P/E with its peers' using the financial data
website Morningstar.com -- here's how Microsoft compares today.
Warning Sign #2: The company's competitive advantage is in
Whether it's through a superior product, brand power, low
prices,patents or technology, a company's competitive advantage is
the wall that keeps competitors from taking awaymarket share and
profits. But if competitors find a better way, a company's
competitive advantage can disappear quickly, and the stock's future
growth could be in jeopardy.
For example, movie-rental company Blockbuster used to beat
competitors with convenience -- by having more stores, more
available movies and flexible return policies. But when competitors
Netflix (Nasdaq: NFLX)
offered mail-order DVD service and movies to stream online from
home, Blockbuster's competitive advantage completely disappeared,
the stock became worthless and the company filed for bankruptcy --
all between 2002 and 2010.
Stay alert: Study the latest headlines about your stock and look
for broad changes in industry trends. Are competitors providing a
better service oroffering a better price? Are consumer tastes
changing, and is the company you are invested in adapting to these
changes better than its competitors? Is the industry as a whole
growing or shrinking? No one can predict exactly whatwill happen as
industries change, but your stock should represent a company that
has a clear edge over competitors in a healthy industry --
otherwise, be prepared to sell.
Warning Sign #3: The company makes drastic changes in its
direction or leadership.
You may have originally bought a stock because you felt the company
had a winningbusiness model and good management that would give you
healthy returns over time. But then the company suddenly changes --
perhaps it loses its visionary leader that carried it to success
Apple's (Nasdaq: AAPL)
Steve Jobs) or maybe the company changes its business model
or vision. Dramatic changes like these can dramatically alter a
company's future performance.
Stay alert: Change is inevitable in almost every company, but if
the business loses the leaders or business model that you felt made
it successful in the first place, it's time to re-evaluate. Do you
feel the company will continue to be successful? Research the new
leaders and changes, follow your instincts and consider dumping the
stock if you feel uncertain of the company's future.
Warning Sign #4: The company's sales are stalling or
While a tougheconomy can make it difficult for companies to keep
sales growing every year, a trend of fallingrevenue may signal that
the company has trouble marketing or selling its products and
services or finding new sources of income.
Stay alert: Watch the company's annualincome statement ; its top
line should have been steady or growing during the past few years.
Ifrevenues are trending downward, especially in an industry where
competitors have experienced sales growth over the same period,
then it may be time to sell if you don't think good times are ahead
for the company.
Warning Sign #5: The company'sprofit margins (and earnings)
Profit margin is simply the percentage of revenue a company takes
in asprofit (after expenses,taxes and interest have been paid). A
trend of shrinking annual profit margins signals that the company's
expenses are rising faster than its revenues -- meaning a company
is having trouble keeping costs under control and keeping profits
Stay alert: As with revenues, look at the company's past annual
income statements to see if profit margins have been holding steady
and thatnet income (profit) has been growing in the past few years.
If competitors have been able to keep their profit margins and net
income growing while your company's earnings have stalled or
declined, then be prepared to hit the sell button.
Warning Sign #6: The company recently cut itsdividend
Management will almost alwaysput a positive spin on things to make
the company's future look rosy to analysts. But a company's actions
will speak louder than words. While a mature company raising its
quarterly dividend payment can signal optimism about its future and
can reward its shareholders with a larger dividend, a company
slashing its dividend payment often is expecting lower earnings and
less growth in the future.
Stay alert: If a company (assuming it pays a dividend at all)
announces it will reduce the size of its dividend payments to its
shareholders, then understand why the decision was made. Some
companies slash their dividend payment to free upcash for research
and development or expansion purposes, which is fine if you believe
it's a good move (see #3 for help on that). But other times, that's
not the case. If you don't want to stick around and weather the
storm of weak future earnings, then a dividend cut announcement may
be yet another indicator that it's time to exit.
Action to Take -->
Knowing when to sell a stock is extremely difficult, even for
professional investors, so look for more than one or two warning
signs before you pull out. The stocks that are really worth selling
likely will carry more than a few of these trouble signs, which
will make your decision easier. If the stock that you hold
represents a company in decline or in a declining industry and the
reasons you bought the stock in the first place have changed
considerably, then it may be time to cash in the chips. On the
bright side, you'll have more cash free to make your next
This article originally appearead on InvestingAnswers.com:
Wondering When To
Sell A Stock? Use This 4-Minute Checklist
© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.