Key Factors for Keeping or Selling Stock
- Stock investing requires a disciplined approach to both buying and selling. When you purchase a stock, purchase it because it provides a compelling value, potential for growth, a solid earnings history if a history is available, and a reliable, capable and honest team of managers. Base your decision for selling the stock around similar considerations: Sell because the stock no longer represents a good value for your dollar, because growth prospects have diminished, or because the management team is compromised.
- Keep watch on the stock's valuation, both intrinsically and relative to peers and other investments. For example, if you purchase a stock with $1 of earnings per share at a price of $5, you have purchased a stock with a price-to-earnings (P/E) ratio of 5, and an earnings yield of 20 percent. If earnings are stable, that is historically a solid bet in any market. However, if earnings remain constant but the stock price moves to $20 per share, your earnings yield has effectively fallen to 5 percent. You may get lucky if the P/E ratio continues to expand, but there is no rational reason to expect that to continue. Consider selling the stock, taking profits and moving on.
- If management proves untrustworthy, it's probably time to sell. When you are a stockholder, you are a partner with management. There is no reason to remain in partnership with dishonest or self-serving people. However, if the managers are honest, hardworking and competent, that is an excellent reason to stick with the company during tough times.
- Changes in legislation, regulation and case law can affect even solid, well-run companies. For example, recent health insurance reforms may affect the profitability of health insurance companies and related industries, regardless of how capable the management team is. If earnings prospects are declining and you can do better elsewhere, consider selling. Even if you have to take a loss, it is better to sell and find a new investment than to hope a business recovers its former stock price, despite its earnings potential being severely degraded by a change in the law.
- When you sell a stock, you must do something with the proceeds, even if you only put it into cash. Every investment carries with it an opportunity cost -- the difference in expected returns between what you are doing with the money and what you could be doing with the money. When you sell, it should be because you have a better idea.
- When you sell a stock at a profit, you are liable for capital gains tax. For long-term capital gains, the current rate as of September 2010 is 15 percent. The long-term capital gains tax rate is scheduled to increase to 20 percent as of January 1, 2011, unless Congress acts to change the law. Any investment you make should not only provide better returns for a given amount of risk, but also compensate you for the capital gains tax liability you will incur. Note, however, that no capital gains tax liability exists in retirement accounts. To mitigate the long-term capital gains tax issue, consider selling some of your losing stocks. Your capital losses offset your capital gains taxes on your individual tax return, dollar-for-dollar.