Investing 101: Know When to Sell Stocks

Source: Thinkstock

Source: Thinkstock

No matter where it originates from, everybody loves a hot stock tip. Whether it comes from cocktail parties, taxi drivers, or the golf course, nothing screams sophistication like discussing the next big moneymaker. However, with many sources focusing on when to buy, people tend to give very little thought ahead of time on when to sell.

When is the right time to sell? The answer depends on your personal financial situation as well as company fundamentals. You should ask yourself two important questions to help sort through emotions: Are my stock picks keeping me up at night? Would I buy these stocks again if I had a mulligan? If your portfolio is consistently keeping you awake at night with regret, something is flawed with your investment strategy. You’re likely too heavily exposed to risk and should make adjustments, sooner rather than later. Delaying a course correction will only hinder your ability to think objectively.

Clinging to stocks that are not suitable for your risk tolerance level also brings along opportunity cost. In addition to losing a good night’s sleep, you are keeping money away from more suitable investments. If your portfolio is weighed down by major losses, hanging onto the losers may keep you from investing money in more attractive areas of the market. This does not mean to automatically sell your under-performers, but if you made a mistake in buying the stock to begin with, hope is never a good strategy to recover your losses.

Even if you’re sleeping well, did your due diligence before buying, and don’t entirely regret purchasing any stocks in your portfolio, you may still need to recognize that underlying fundamentals are changing at some companies. If sales, earnings, profit margins, cash flow, or other fundamental metrics are showing significant declines, it may be time to acknowledge that the industry in which the company operates in is changing, or competition is heating up.

Most recently, the food industry is witnessing a dramatic shift as consumers lose their appetites for lackluster burgers and service. Shares of McDonald’s (NYSE:MCD) have struggled over the past couple years. In the latest earnings release, global sales were flat at McDonald’s and the chief executive officer said, “We’re focused on fortifying the foundational elements of our business by concentrating our efforts on compelling value, marketing, and operations excellence to become a more relevant and trusted brand.” Those are not exactly encouraging words. Shareholders should be asking themselves if they want to wait on a questionable turnaround.

Warren Buffett once said, “Be fearful when others are greedy, and greedy when others are fearful.” In other words, investors should sell stocks when everyone else is rushing to buy but remember to buy stocks when the crowd is panicking. Activist investor and billionaire Carl Icahn displayed the “fearful” part of this wisdom perfectly last year. After buying Netflix (NASDAQ:NFLX) shares at a cost basis of only $58 per share, he sold nearly 3 million shares, nearly half of his position. Icahn initially started to sell shares between $296 and $307, and sold a large amount at an average price of $341.

Interestingly, Icahn sold the largest amount of shares after Netflix reported better-than-expected earnings — fundamentals had nothing to do with his decision to sell. At the time, Netflix more than tripled in a few months and was the best performer in the S&P 500. Not taking profits would be nothing short of outright greed. Icahn recently performed a similar action by selling a large portion of his Family Dollar (NYSE:FDO) stake after a large run-up after buyout news. Sometimes you need to sell a stock simply to lock-in profits and avoid being greedy. Remember, paper profits are only realized if you sell.

“As a hardened veteran of seven bear markets I have learned that when you are lucky and/or smart enough to have made a total return of 457 percent in only 14 months it is time to take some of the chips off the table,” Icahn said in a statement. He still maintains a position in Netflix to this day. Investors should note that you don’t have to sell all at once. The best investors in the world can’t perfectly pick tops, chances are neither can you.

More from Personal Finance Cheat Sheet:

Follow Eric on Twitter @Mr_Eric_WSCS

Want more great content like this? Sign up here to receive the best of Cheat Sheet delivered daily. No spam; just tailored content straight to your inbox.