What I’m Drinking as I Write – Black Eye Coffee
- 2 shots of espresso
- 1 cup coffee
- Brew, combine, and enjoy
Congratulations. You’ve found a company you understand and want to invest in, so you’ve finally purchased a share of its stock. The next question is – when are you selling out? A large part of purchasing a stock is knowing when to sell. There are many ways you can go about doing this.
One “selling point” for a stock you purchased could be when the stock price hits a certain dollar amount. Maybe this amount is twice as much as you purchased it for (you bought a stock for $100 and want to sell it when it hits $200). Maybe this amount is after you have earned a solid 25% return (your $100 stock is now priced at $125).
Another possible time you could consider selling is if a stock has seen a recent increase in activity, and the stock is trading up faster than you could imagine. You may choose to sell out at this time if you do not think the stock should be valued this highly (remember, a stock price does not reflect what you think it should be worth, it’s what other investors think it’s worth).
Bad News: Perhaps the stock you purchased announced unexpected bad news and the stock is down 25%. Even though you initially liked the stock enough to purchase it, do you like it even more now after the bad news and discounted price? Or, is this bad news what you believe to be only the beginning, and you should sell the position now before seeing any additional downside?
Good News: Let’s say the stock you purchased announced amazing and unexpected good news and the stock is up 25%. Do you still believe the stock is fairly valued and will be worth even more in the future? Or, is this new price more than what you believe the company’s stock deserves to be valued at, and you should sell now before other investors realize this too?
Re-Weighting a Portfolio
Typically when you purchase a stock you do not put 100% of your available money in it (I hope). You may choose to target a percentage of your portfolio (all the stocks you own), say 5%. If a stock has recently outperformed, it will now make up a larger percentage of your portfolio (now it’s 10%). Even though you may still believe in the future growth of the company, you should remember that risk is an important concept to be mindful of, and the larger this holding gets, the greater your individual company risk becomes. You may consider selling a few shares of this holding to bring it back to your original [5%] target.
Sometimes there is nothing wrong with a company or its share price, yet it still may be a good time to sell. Let’s say you purchased Company 123 and it has excellent revenue and earnings growth estimates over the next year, its shares are fairly valued, it’s in good financial shape (very little debt, etc.), and it sells a great product that its customers love. Then you recently come upon Company 456 and decide to do a little research (just for fun, right?). You find this company also has great revenue and earnings growth estimates, is in good financial shape, and sells another very good product to its customers. However, it doesn’t seem like other investors have taken notice – this stock is very undervalued. Even though you still like Company 123, if there is a slightly better chance you could earn more on Company 456 (its shares do appear undervalued, after all), why not take the chance?
Last year I was reviewing my portfolio and looking for new companies to invest in when I found a company I believed to be undervalued. Its shares were down drastically over a short period of time, so I decided to look into the company. This company’s balance sheet was fine – it had some debt, but the company could handle it (enough free cash flow for several years). It had a backlog (products/services ordered in advance) that was booked for the next two years. Demand appeared to be increasing, revenue and earnings growth were expected to increase over the next several years, and shares looked very under-priced (the share price was down an extreme amount). I really wanted to purchase this stock to add to my portfolio. The only problem was, I did not have any cash available. At this time last year, many other positions in my portfolio had losses (the current value of the stock was below what I purchased it for). I decided I would rather sell out of a position with a loss that may not offer as good a return than miss out on my chance. I realized (officially sold out of a position) a nearly 10% loss when I sold this position. I used the entire amount to invest in the other company. Over one year later and I’m only up 1.9% in my new position. Had I stayed in my previous position, I’d be up 54%.
There may never be a right time to sell, so please don’t sit on the edge of your chair waiting for one. Sometimes you will sell at the completely wrong time. But this is part of the process, right? The other investors in the market don’t have to agree with me or my timing, and more times than not (in the short-term at least) they won’t. Over the long-run, investors will notice and stocks will correct themselves – prices will reflect what the company deserves to be valued at. But in the short-term don’t expect to get the timing right, it will only hold you back from additional opportunities and gains in the future. Find a company you believe in and take a chance on it. Get it wrong a few times. Just don’t put 5%+ of your portfolio in any one stock (remember, it is real money and you could lose it all).