How do you know when it’s time to sell a winning stock?
Most investors have asked themselves (or me and my fellow Cabot editors) that question on at least one occasion.
When a stock has appreciated—a lot or a little—since you added it to your portfolio, it can be hard to decide whether to lock in the profits or hold out for even more upside. In fact, we know from our conversations with subscribers that selling winners is one of the hardest decisions for most investors to make.
Today I thought I’d try and make it a little easier by sharing some “real life” case studies—actual sell alerts from recent Investment Digest and Dividend Digest issues—and the reasons behind them.
1. Sell After A Set Period of Time
This is not a common sell discipline; but it’s a discipline (important) and it’s simple and easy to follow. And it works for Neil MacNeale, the editor of 2 for 1 Stock Split Newsletter. MacNeale’s investing strategy is based on research (the Ikenberry/Rankine study) showing that stocks enjoy two to three years of outperformance after undergoing a two-for-one split. So, with some flexibility built in for profit-taking, he holds each of his picks for two and a half years—30 months—and then sells it.
Most recently, he sold Tractor Supply Co. (TSCO), which he bought in August 2010 (30 months ago) at 34.15. The recommendation was picked up by the Investment Digest later that month, so we also included his 30-month sell order in our latest issue. Here’s what he wrote:
“Tractor Supply Co. (TSCO) has been a terrific stock for the 2 for 1 portfolio over the last two and a half years. It’s always hard to let go of a winner like TSCO but our buy/sell routine is important here. And a close look at the numbers tells me this is not a bad time to sell. TSCO is near its all-time high, its P/E and price-to-book ratios are far higher than when we bought and, given the number of analysts covering the stock, it has now been ‘discovered’ by Wall Street—not a good thing, in my opinion. We sold a portion of our TSCO position in October, 2011, for a 78.4% annualized return. The remaining shares were sold on April 5, 2013, for a 53.4% annualized return. Thank you TSCO!”—Neil MacNeale, 2 for 1 Stock Split Newsletter, April 19, 2013
In this case, the “sell after a set period of time” discipline worked particularly well because a) TSCO was undiscovered and undervalued when MacNeale bought in, and became less so over time, and b) MacNeale took some profits off the table after the stock appreciated significantly, locking in part of his gain.
The most important part of this sell discipline, though, is that it is based on and works well with MacNeale’s investing system. It’s most useful for investing systems with a time-related component: like buying undervalued cyclical stocks, for example. Do you use a sell system with a time component? Let me know by replying to this email.
2. Sell When the Negatives Outweigh the Positives
This is a more popular, but less rigid (and thus harder to follow) sell discipline. In this kind of system, you hang on to a stock that’s performing well until the factors supporting further upside begin to be overshadowed by factors suggesting downside.
An example was supplied by Louis Navellier, Editor of Blue Chip Growth, in the latest Investment Digest. Navellier recommended Starbucks Corp. (SBUX) in the June 6, 2012, Investment Digest, and after some weakness last summer, the stock delivered a nice gain this winter and spring. Although the stock is still acting well, Navellier recommended selling earlier this month, citing weakening buying pressure. Here’s what he wrote:
“I want you to take profits today in Starbucks Corp. (SBUX). … After going over the latest stock data this weekend, I noticed that buying pressure for SBUX dropped to the point where I no longer want us holding with downside risk increasing. We’ve seen a tidy 14% gain since we added this stock last May.”—Louis Navellier, Blue Chip Growth, April 15, 2013
This strategy was also employed by a contributor in the previous Investment Digest issue. The Complete Investor Editor Stephen Leeb decided to sell Eli Lilly & Co. (LLY), which he recommended around 40 in June 2012, because the headwinds against the stock were picking up. Here’s what he wrote:
“While it has some potentially strong drugs in its pipeline, progress on its Alzheimer’s drug has been slower than we expected, with approval, if it comes at all, not slated until the decade’s second half. We also question the company’s diabetes strategy. Lilly has a lot of ground to make up as many of its proprietary drugs become open to generic competition in the next few years, and there is very little room for mistakes. Sell Eli Lilly.”—Stephen Leeb, PhD., The Complete Investor, April 2013
Like SBUX, LLY was still acting well, trading around 56, when Leeb recommended selling. But his analysis showed that downside factors could begin to outweigh upside factors any day, and that there was “very little room for mistakes.”
Although it can be tricky to weigh the positive and negative forces acting on a stock if you’re not a professional investment advisor, this system does offer the promise of safeguarding gains in winning picks by selling before a downturn begins.
3. Sell Some to Lock in Gains
Another way to safeguard your gains is to take partial profits in your winners while their uptrends are still strong.
If you have a big profit in a stock, but still believe in the stock’s story and technical strength, you can safeguard some of your gain by taking partial profits off the table while leaving the rest to take advantage of further upside.
If the stock has run especially far or fast—particularly if it’s doubled or more—one method I’ve seen many of our contributors use is to take their original investment off the table and let their profits ride. That way you feel secure that you can’t “lose” any money if the wild ride ends (after all, you already got your original investment back). Last month, Small Cap Investor PRO Editor Tyler Laundon recommended just that in the Investment Digest. This stock that he recommended in the Digest in February 2012 at around 25 had recently doubled:
“I recommend you sell half of your position in Susser Holdings Corp. (SUSS) around $48.75 to lock in a 101% gain. Doing so means that you’ll take your original capital off the table and let the pure profits ride. Note that I’m only recommending this as a step to protect the gain and not because I don’t believe in Susser’s future growth potential. In fact, Susser remains one of my favorite stocks in the markets—but it’s been on a heck of a rally lately, and the prudent thing to do is lock in some of the gain. Congratulations to all of you who purchased shares of Susser Holdings. Sell half your position in Susser Holdings (SUSS) around $48.75 to lock in the 101% gain.”—Tyler Laundon, Small Cap Investor PRO, March 22, 2013
4. Sell When a Stock Reaches Your Target Price
Selling when a stock reaches your target price is another system-specific sell discipline that has some advantages. For one thing, choosing a target sell price before buying a stock makes the sell decision much easier—your judgment isn’t clouded by how much money you’ve made on the stock. It also forces you to reconsider how much upside may be left in the stock at current levels. Of course, like selling after a certain period of time, you should build some flexibility into the system, to ensure you aren’t missing out on big winners or letting profits evaporate.
In a recent Dividend Digest, The Prudent Speculator Editor John Buckingham recommended selling a stock that had reached his target price. Here’s his reasoning:
“STMicroelectronics NV (STM) bumped up against our long-term Target Price this week, prompting a decision as to whether to boost our valuation assessment or to free up the cash to invest in something that may be more attractively priced. Though we were tempted to lift our long-term price objective, the fact that the shares were trading for more than 13 times the 2014 earnings estimate as well as for average price to book value and price to sales multiples compelled us to cash in our STM chips.”—John Buckingham, The Prudent Speculator, 1/18/13
5. Sell When the Chart Turns Down
Finally, there’s the defensive sell, to protect your investment and whatever profits you have when a stock starts to weaken. This is probably the most important sell discipline, and should be used regularly by every investor.
In a recent example in the Dividend Digest, Wall Street Stock Forecaster Editor Patrick McKeough recommended selling The McGraw-Hill Companies, Inc. (MHP) after the stock took a tumble. McKeough had recommended MHP around $37 in the March 2011 Dividend Digest issue, so he protected some of his profits by selling around $48 after the stock suffered a big drop:
“The McGraw-Hill Companies, Inc. (MHP) fell over 25% this week after the U.S. Department of Justice announced that it is suing the company’s bond-rating subsidiary, Standard & Poor’s, over its role in the 2008 financial crisis. … It will take years to settle these lawsuits. And even if McGraw-Hill settles, the payments could wipe out much of the cash from the sale of the textbook division. The lawsuit could also prompt regulators to open up the bond-rating industry to more competition. Right now, Standard & Poor’s, Moody’s and Fitch account for 95% of the global bond-rating market. We now see McGraw-Hill as a sell.”—Patrick McKeough, Wall Street Stock Forecaster, February 8, 2013
As you can see, there are many answers to the question of when it’s time to sell a winning stock. In many ways, the decision to sell a winning stock is much more complicated than realizing you need to sell a loser. Losers should always be sold because they’re doing poorly, but there are a wide variety of reasons to sell a winning stock.
As always, I’m curious to know your thoughts on the topic. Just click reply on this email and tell me: how do you decide when to sell a winning stock? Have you used any or all of these sell disciples, or do you have another strategy that I didn’t mention? I look forward to reading your replies.
Wishing you success in your investing and beyond,
Editor of Investment of the Week