Wondering When to Sell a Stock? Use This 4-Minute Checklist
by Christian Hudspeth
As an investor who loves to buy, hold and collect returns from my, I usually hate the idea of having to sell one of the in my portfolio.
After all, I'd like to think that I invested in good companies that didn't ever need to be sold.
But sometimes eventhat have delivered years of solid returns lose their stride. Other times a good company may become mediocre. And then there are times when you discover you chose a bomb of a instead of a treasure.
Meanwhile, dozens of other potentially great stocks await that could make your grow much faster -- so why not just dump the that's not performing?
Because selling for the wrong reasons can be a costly mistake. It's much easier to buy athan to know when you should sell one.
Many investors are reactive and sell at the same time everyone else does -- when they're fearful. But your emotions aren't the best guide for making critical financial decisions. Look at how investors have reacted to market downturns during and after the 2008 financial crisis:
As you can see, investors often react and sell after it's too late. Other times they hold on and keep losingon a soured . That's why it's important to be proactive, watching the finances and moves of the company behind the you own so you can see the warning signs before your falls (or in some cases, plunges further than it has already).
While it's generally a good idea for most investors to sell sparingly, here are some emotion-free signs that say it's finally time to sell a:
Warning Sign #1: Your stock has a shockingly high P/E ratio.
While you may have enjoyed healthy gains from a that you've held onto for years, keep an eye on its price-to-earnings ratio (P/E), which essentially compares the company's most recent earnings to its price. Just as a relatively low can signal that a is a bargain, a relatively high can indicate that a is overpriced and ready for a plunge.
Case in point: From 1990 to the end of 1999, Microsoft's (Nasdaq:MSFT) overvalued, many dumped the and MSFT shares lost nearly two-thirds (63%) of their value over the year 2000.skyrocketed over 15,600%. However, its showed the had climbed well into overpriced territory, trading at a price that was 84 times what it was earning per share. Once investors realized that the was
Stay alert: While a highdoesn't always mean a is overvalued (growth sometimes have much higher ratios), you may want to investigate further if your has a that is significantly higher than its industry peers' or the overall market's (historically it's been between 14 and 17). You can compare a company's with its peers' using the financial data website Morningstar.com.
[For more ways to see if a company is overvalued, read The #1 Rule Every .] Investor Needs to Know
Warning Sign #2: The company's competitive advantage is in danger.
Whether it's through a superior product, brand power, low prices, competitive advantage is the wall that keeps competitors from taking away market share and . But if competitors find a better way, a company's competitive advantage can disappear quickly, and the future growth could be in jeopardy.or technology, a company's
For example, movie-rental company Blockbuster used to beat competitors with convenience by having more stores, more available movies and flexible return policies. But when competitors like Netflix offered mail-order DVD service and movies to stream online from home, Blockbuster's competitive advantage completely disappeared, the bankruptcy -- all between 2002 and 2010.became worthless and the company filed for
Stay alert: Study the latest headlines about yourand look for broad changes in industry trends. Are competitors providing a better service or a better price? Are consumer tastes changing, and is the company you are invested in adapting to these changes better than its competitors? Is the industry as a whole growing or shrinking?
No one can predict exactly whathappen as industries change, but your should represent a company that has a clear edge over competitors in a healthy industry -- otherwise, be prepared to sell.
Warning Sign #3: The company makes big changes in its direction or leadership.
You may have originally bought a business model and good management that would give you healthy returns over time. But then the company suddenly changes -- perhaps it loses its visionary leader that carried it to success (like Apple's Steve Jobs) or maybe the company changes its business model or vision. Dramatic changes like these can dramatically alter a company's future performance.because you felt the company had a winning
Stay alert: Change is inevitable in almost every company, but if the business loses the leaders or business model that you felt made it successful in the first place, it's time to re-evaluate. Do you feel the companycontinue to be successful? Research the new leaders and changes, follow your instincts and consider dumping the if you feel uncertain of the company's future.
Warning Sign #4: The company's sales are stalling or falling.
While a tough revenue may signal that the company has trouble marketing or selling its products and services or finding new sources of income.can make it difficult for companies to keep sales growing every year, a trend of falling
Stay alert: Watch the company's annual income statement; its top line should have been steady or growing over the past few years. If are trending downward, especially in an industry where competitors have experienced sales growth over the same period, it may be time to sell if you don't think good times are ahead for the company.
Warning Sign #5: The company's profit margins (and earnings) are shrinking.
Profit margin is simply the percentage of a company takes in as (after expenses, and interest have been paid). A trend of shrinking annual signals that the company's expenses are rising faster than its -- meaning a company is having trouble keeping costs under control and keeping up.
Stay alert: As with net income ( ) has been growing over the past few years. If competitors have been able to keep their and net income growing while your company's earnings have stalled or declined, be prepared to hit the sell button., look at the company's past annual income statements to see if have been holding steady and that
Warning Sign #6: The company recently cut its dividend payment.
Management analysts. But a company's actions speak louder than words. While a mature company raising its quarterly dividend payment can signal optimism about its future and can reward its shareholders with a larger dividend, a company slashing its dividend payment often is expecting lower earnings and less growth in the future.almost always a positive spin on things to make the company's future look rosy to
Stay alert: If a company (assuming it pays a dividend at all) announces that it cash for research and development or expansion purposes, which is fine if you believe it's a good move (see #3 for help on that). But other times, that's not the case. If you don't want to stick around and weather the storm of weak future earnings, a dividend cut announcement may be yet another indicator that it's time to exit.reduce the size of its dividend payments to its shareholders, understand why the decision was made. Some companies slash their dividend payment to free up
When to Sell a Stock -- Putting it All Together
Knowing when to sell ais extremely difficult even for professional investors, so look for more than one or two warning signs before you pull out. The stocks that are really worth selling likely carry more than a few of these trouble signs, which make your decision easier.
If thethat you hold represents a company in decline or in a declining industry, if the reasons you bought the in the first place have changed considerably, if the is overvalued or if the suffers from all of the above, it may be time to cash in the chips. On the bright side, you'll have more cash free to make your next great .