“Buy low and sell high.” That’s the cardinal rule of investing. The only problem is that you don’t know what’s going to happen the day, the week, the month, or even the year after you buy or sell. Anyone who has been investing for a while knows the feeling of selling a stock they’ve held for a while, only to have it spike in price right afterward.
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So, how do you know when the time is right to sell an underperforming stock? Here’s what you need to know.
Watch the Fundamentals
By tracking a company’s fundamental information – its cash flow statement, balance sheet, and income statement – over time, you can get a good idea of whether it is on an upward or downward trajectory with respect to performance. Looking at the company’s competitors will give you some insight into whether it is likely to continue the way it is going or if it has some advantages or challenges compared to others in the same industry.
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Look for a Better Opportunity
A stock doesn’t need to be performing particularly poorly for you to consider jettisoning it from your portfolio. If there is another stock in the same sector that looks like it has more upside than the one you own, sell your position and buy the one with more potential.
Beware of Overvalued Stocks
Warren Buffett is famous for buying undervalued stocks and holding them until the rest of the market figures out they’re a bargain and drives up the price. So, Buffett watches carefully and drops overvalued stocks.
Buffett has been quoted as saying, “The stock market is designed to transfer money from the active to the patient. But if the price is way higher than the intrinsic value, then it’s better to sell.” This makes a lot of sense as long as you can quantify a stock’s intrinsic value.
Buffett himself defines intrinsic value as “the discounted value of the cash that can be taken out of a business during its remaining life.” The issue, of course, is determining that value.
Buffett and his late partner Charlie Munger have tried to identify how they arrive at intrinsic value, but in the end, like any prediction of the future, there’s a fair amount of guesswork. Consider the sector in which the company operates, its competitive advantages in the sector, and the likelihood that it will continue to perform at its current level or beyond. Overvalued stocks are challenged to perform at the level that is indicated by their stock price.
A Mismatch in Values
Investors today are more likely than ever to consider their values when choosing stocks to buy – or to sell. If a company you own gets into a line of business that you object to, that’s a good reason to sell that stock. After all, when you buy stocks, just like any other discretionary purchase, you are voting with your wallet. You are saying that what you are buying is worth the price you are willing to pay for it. If you think a company’s values contradict your own, dumping their stock is a way of making your feelings known.
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This article originally appeared on GOBankingRates.com: How To Know When It’s Time To Drop a Stock
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
