Correction: A penny stock I mentioned recently as being on the New York Stock Exchange, symbol CN, is actually traded on the considerably less prestigious American Stock Exchange. Sorry for the slip.

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From Jarett Chaiken: “I just started investing a few months ago, and have been reading everything I can get my hands on to bring me up to speed, and I’ve found countless articles and books that tell me how to pick stocks, what to look for, and what to expect. What I haven’t found is anything telling me when I should sell. The best I can find is ‘Sell when the reasons that you bought are no longer valid.’ This seems unreasonable to me. If I follow that line of reasoning, the day I don’t want to buy it anymore I should sell. Once I decide to buy a stock, I want to have a solid exit strategy; and if I can’t come up with one, then maybe I should re-evaluate why I wanted to buy it in the first place.

“To pick on one of your favorites [Jarett is being wry here], I’ve heard plenty of people tell me to buy Amazon shares because they keep going up and don’t show signs of stopping (Why? I’ll never know) but then, when do I get out? The same time everyone else discovers that it’s overvalued and sell at a loss?

“I’m not expecting any ironclad guarantee to make money, but if I lose a money I’d like it to be because of my bad judgement in planning rather than my failing to plan.”

A.T.: It is, of course, an excellent question, especially because traditional Wall Street analysts are much quicker to recommend buying a stock than selling it. (Analysts want management to answer the phone next time they call; Wall Street firms sometimes hope for underwriting business from the firms they write reports about.)

There’s a book called When to Sell by Justin Mamis (most recent update: 1994) you might want to check out. But (absent the effect of taxes) the answer is to sell any stocks you don’t strongly feel you should own – based on solid fundamentals, not voodoo: They pay a high dividend (which almost none do these days) or they are selling cheap relative to their assets and/or their earnings and growth prospects.

Look, you can get an absolutely safe “stock” that currently “grows” at 5% a year with no chance of loss – short/intermediate-term U.S. Treasury bonds. So for you to take the considerable risk of tying up your money and/or losing 80% of it (or even 100%) on a stock, you need to really believe you have some understanding of why it’s worth taking that risk.

The famous Warren Buffett avoids high-tech stocks because he doesn’t understand them. This may be good advice for the rest of us as well. (If you ever felt that, as a group, they had unreasonably fallen into disfavor, you might certainly buy them as a group, not trying to divine which will be the winners. Either construct a little portfolio, or buy one of the high-tech “sector funds” where, for a fee, experts will choose the specific stocks for you.)

If you’re a techie and have good reason to believe in the management and/or products-in-the-pipeline at a firm you know well (a supplier? a competitor?) but that is undiscovered as yet on Wall Street … well, that would be a good reason to buy its shares.

If you find a stock yielding 6% versus the Treasury’s mere 5% … and you think, based on your research, earnings (and thus, some day, dividends) are more likely to go up than down … then THAT could be a good reason to pass up a certain 5% in favor of 6%.

Indeed, even a stock that pays no dividend, or just a small one, could be a great and compelling buy if it were selling at a low multiple of its current or future realistic earnings.

But ultimately, despite long periods of musical-chairs markets and euphoric markets (and, for that matter, sinking-ship markets and overly-despairing markets), stock prices will be determined by assets and after-tax earnings potential (and by the level of interest rates on competing investments like bonds).

So, yes, you might want to re-evaluate the stocks you’ve bought. And don’t feel like an idiot if you can’t find compelling reasons to give up the safety of 5%. There’s no rush. Work at it long enough (and/or let the market drop far enough, if that’s what happens), and you’ll find lots of them.

Of course, the other way to approach this is simply to put a steady monthly sum into two or three no-load, low-expense index funds (or equivalent “stocks” like SPY, MDY, DIA and WEBS), and never sell until, decades from now, you actually need the money. (Well, you’d start selling some years before you need the money … money you really need within the next 4-5 years should not be in the stock market, especially at times like now, when it’s still near it’s all-time high, both in absolute terms and in terms of price/earnings ratios and the rest.)

Long-term success in the market most often comes from buying shares in good companies, not so much because you think they will go up (though that’s the ultimate goal) as because you want to own a piece of the business and profit from its long-term success, getting a piece of the profit each year and, in most years, seeing that profit grow. It is not dumb to hold some shares for the better part of a lifetime, as Buffett has held GEICO and the Washington Post Company and others, especially in taxable accounts. It is dumb to sell too often, taking lots of taxable gains, because the taxes will greatly diminish your long-term success. (This is another reason “index” funds and instruments fare relatively well; they generally do little selling, and thus generally keep the tax bite low.) That said, if you hold a stock that seems to be gripped by craziness and euphoria, as Avon was in the early ’70s at 140 a share (decent company though it was and remains), or whose long-term prospects do not seem bright, it doesn’t make sense to hold on just to avoid taxes. (Though the company continued to do reasonably well, Avon stock dropped 87% in two years before bottoming out and beginning a very gradual recovery.)

In sum: “When to sell” is an agonizing question to which my answers are as unhelpful as everyone else’s – but a question you are right to consider even before you buy.



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