3 reasons to sell a stock and 1 big reason not to | Personal finance
(Mark in white)
If you’re a long-term investor, it’s easy to put off the topic of selling. After all, if you invest well, you will hopefully seldom sell.
That being said, it’s important to understand when to sell a stock, even if the scenarios are few and far between.
Reason #1: You made a mistake
This one is the hardest to accept. But getting a thesis wrong every once in a while for a company is only part of the investment process. Being able to recognize your flawed thesis early is key to mitigating any losses you may incur.
This is why it is important to have a written thesis. When I was a new investor, I found reasons why I liked a certain company, but often didn’t take the time to document them. Years later, I wondered why I bought the stock in the first place. More than once, I sold it at a loss for lack of conviction.
People also read…
If you put pen to paper (or more likely, fingers to keyboard) and write your thesis on why you’re bullish for the company, it’ll be easy to revisit during turbulent times to see if your original thesis is still on track or completely broke.
Reason 2: The stock has reached its ceiling
One of the most important numbers to estimate when researching a potential investment is the company’s market capitalization cap. Market capitalization is the total value of all outstanding shares of the company, and the cap is your estimate of the peak of a company’s market capitalization growth. In simpler terms, if Company A has a market capitalization of $1 billion and its addressable market is $5 billion, the cap represents how much of that addressable market you think Company A can capture.
Take Assets received (NASDAQ: UPST) for example. The lending software company saw its stock soar from $44 when it went public to nearly $400 less than a year later. That’s a return of 784% in less than 12 months!
The unsecured personal loan market is an industry of approximately $144 billion. While Upstart is disrupting this industry with its artificial intelligence (AI)-based underwriting alternative, in 2021 the stock market had valued a nearly 25% market share for Upstart at a market capitalization of $33 billion. dollars. At this price, it’s hard to see any significant benefit to the company, even if it works flawlessly.
Of course, the hindsight is 20/20, but this example highlights the importance of having a rough estimate of the ceiling in case the stock takes a head start, as Upstart did. If the stock exceeds your cap price, you should either recalculate your cap (due to an unforeseen option) or seriously consider exiting or at least reducing your position.
One of the reasons you might re-estimate your cap is that the company has expanded into new markets or developed new products since your thesis was written. This is called optionality.
If you invest in growing companies, you should review your limits regularly. High growth companies are dynamic and often part of the bullish case is the optionality of the company. Amazon is a prime example of a company that most investors probably wouldn’t have dreamed of reaching a trillion-dollar market capitalization in the late 1990s.
Yet, if you had stayed on top of the business throughout its growth, you would have recognized the incredible new markets and products it continually introduced (Amazon Web Services, the entertainment industry, logistics, etc.) and adjusted the ceiling accordingly.
Reason #3: You need money for something important
We all have our reasons for investing. These goals can include things like buying a house, paying your child’s school fees, helping the family, or even starting a business.
While ideally you should try to save for those expenses outside of your stock portfolio, life doesn’t always run on our schedule, and selling stocks to pursue really important things can sometimes make sense.
If you’re selling for this reason, have a system in place. If you’re someone who doesn’t like to see individual positions become too concentrated, consider reducing some of your winners.
If, on the other hand, you like to manage your portfolio by focusing on your highest convictions, consider selling your less convinced holdings.
A very bad reason to sell
Perhaps the worst reason to sell a stock is simply because it is going down. Unfortunately, the pressure from social media and financial news to do so is strong when the market crashes.
The price of admission to the world’s greatest wealth-creating machine – the US stock market – undergoes corrections from time to time. That doesn’t mean you should never sell a stock if it’s crashing; you shouldn’t do it uniquely because it crashes.
It is perfectly plausible that there is a thesis-breaking development in the business that drives the price down, in which case the sale may make sense. But as we have seen in this current macro-fueled bear market, stock prices can very easily disconnect from underlying activity. And for patient, long-term investors, that usually means opportunity.
Conclusion: Have a good reason to sell
Just as you wouldn’t buy a stock without doing your due diligence, you shouldn’t sell one without a very good reason to do so. There are certainly other legitimate reasons why investors might sell stocks in addition to those listed above (such as to reduce your capital gains tax bill), but long-term investors need to establish a rationale. well documented before selling.
Once you accept this reality, you will find that the best decision is usually to do nothing.
10 stocks we like better than Walmart
When our award-winning team of analysts have investment advice, it can pay to listen. After all, the newsletter they’ve been putting out for over a decade, Motley Fool Equity Advisortripled the market.*
They have just revealed what they believe to be the ten best stocks for investors to buy now…and Walmart wasn’t one of them! That’s right – they think these 10 stocks are even better buys.
Equity Advisor Returns 2/14/21
Suzanne Frey, an executive at Alphabet, is a board member of The Motley Fool. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Mark Blank has positions in Upstart Holdings, Inc. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple and Upstart Holdings, Inc. The Motley Fool recommends the following options: long March Calls $120 in 2023 on Apple and short calls on $130 in March 2023 on Apple. The Motley Fool has a disclosure policy.