Thursday, 24 January 2013

What to do???

Canadian MoneySaver, Peter Hodson, canadian money saver, investing, stocks
Peter Hodson
One of the hardest things for individual investors to do is to know when to sell a stock. Many times, you might sell simply because a stock has gone up and you've made some money. More often than not, though, this is not a great reason to sell. You will never—ever—have a 10-bagger if you sell a stock after a two-bagger.

Most investors understand this in concept, but many practical reasons get in the way. First, for the average investor owning, say, a portfolio of bank, energy and utility stocks, it is next to impossible these days to even get a double on a stock. If you are buying larger, blue chip, dividend paying companies, you need to settle for a lower return, and might be very happy with a 10% gain. Or, many investors simply find they need the money, and just can't let a winner ride because life expenses get in the way. For retail and professional investors alike, it is always easier to sell a stock that is up.  Third, there is a whole army of market participants that WANT you to sell your stocks. Your broker may have a new investment idea that they want you to switch into. An analyst may downgrade a company, causing you to worry about its prospects. Short sellers may make you nervous about what you might not know about a company. Stock message boards might make you panic even more.

So, if you are an individual sitting on a 30%+ gain on a "normal" type of company (i.e. not a high-growth small cap or a resource exploration play) then what to do?

Here are some things to consider:

  • Compare your company's returns with the market's returns. In the post 2008 recovery, for example, even stable blue chips doubled. If you had an absolute return target in mind, you might have sold at that target and missed out on much bigger gains in the full market recovery. Always consider your gains in the context of what else is happening.

  • Watch the weighting of the company in your portfolio. Often, the best reason to sell is for diversification purposes. If you have more than 20% of your assets in any one company, then you are really taking a "bet" on that company, because your portfolio’s results will be tightly tied to its performance. That is not investing, it’s gambling. Selling for diversification purposes also helps you take the emotion out of your decision.

  • Watch the yield on your investments. If you can find higher dividends elsewhere, you might improve your income by switching into something else. Keep in mind, though, that you will likely pay 23% capital gains taxes, so if you are switching just for yield your new investment needs to yield that much more than your old investment, or you won't be any better off, after taxes.

  • Watch for dramatic changes at the companies you own. Rapid management turnover, increased debt loads, a change in business direction (like buying a brand new business unrelated to the current business) or adding tons of debt may also be reasons to sell. Basically, you want your companies to be slow and steady growers—boring yes, but boring is often the best when it comes to your investments.

If those are a few reasons for selling, what, then, might be reasons NOT to sell? I would suggest the following might not be good reasons to sell:

  • (a) Analyst downgrades. These happen too often, and, unfortunately, don't have a highly accurate track record;

  • (b) Missed quarterly earnings: In my view, if you have a five to ten year investment horizon and you sell because a company missed its 90-day earnings, you may need to examine whether you are, in fact, a trader rather than an investor.

  • (c) Insider selling: While I never like it when company executives sell their own stock, it does happen, so the executives can pay taxes, buy houses and so on. Rarely does it mean individual investors in the stock should sell also. One caveat here, though. If a senior executive sells ALL of their stock, it is generally a pretty good warning sign that something is not right at the company.

  • (d) Because it is up. Just because a stock is up doesn’t mean you should sell. Find out why it is up—accelerating earnings maybe, or better cost control. While it is true you will never grow broke taking a profit, you will pay taxes and may miss out on a true long-term winner. 

Peter Hodson, CFA
Canadian MoneySaver 

1 comment:

  1. Peter, this is an excellent post! :)

    It's tempting for most investors to sell their stocks at 30% or even 40% gains. But if you buy a great company, it's a much better approach to keep the dividends rolling in, and top-up on the dips.

    Inspired by Lowell Miller's, The Single Best Investment, I wrote this point about holding dividend paying stocks:

    My stocks which I view as businesses are the “cogs in the machine” that continue to drive my income through “dividends”. My bonds and bond ETFs are much the same. If I start breaking down the machine and selling off the parts, then I will no longer have a machine. I’ll simply have a pile of cash without any cash-flow!