When should you sell?
Recently I received an e-mail from an investor who had managed to get himself into deep trouble.
He had purchased shares in a stock that had been recommended in a newsletter to which he subscribed. Subsequently, the letter issued a sell signal on the stock, explaining that it was not living up to expectations and that the outlook for improvement was not good.
At the time, the shares were down 47 per cent from the original price. No one likes to take a loss, especially of this magnitude, but there are times when you have to bite the bullet. However, the investor decided to ignore the sell advice and to hold on. As he explained in his e-mail, he was hoping to get back to break-even at which point he would get out.
That never happened. Instead, the company’s situation continued to deteriorate and the stock’s slide became worse. By the time he wrote to me, the shares were trading for pennies. Had he sold when the newsletter advised doing so, he would have received US$4 a share. What should he do now, he asked plaintively.
Unfortunately, there was nothing he could do. When I checked out the stock, I found it had been delisted. There w no market for his shares. He ended up taking a 100 per cent loss!
This sad incident again reminds us that knowing when to sell is perhaps even more important than knowing when to buy. Hanging on to a stock for too long can be dangerous to your financial health. So let’s go over some basic rules for selling.
Sell when you reach your target price. Whenever you buy a stock, always set a target selling price both on the upside and the downside. Record the targets and monitor the movement of the stock on a regular basis. Some stock-tracking programs will automatically alert you when a position hits a target price.
When the shares reach the target, it is a signal to take action promptly. Don’t postpone it because you are busy at the time or you’re likely to regret it. If the shares have reached your upside target and you still like the stock, at least sell half the position and move your downside target to the original purchase price. That way, you guarantee yourself a profit no matter when happens later.
If the downside target is reached, take the loss and move on. This is where many investors run aground. They can’t bring themselves to sell so they hang on in hopes of a recovery. Too often, it never comes.
At times, a situation may arise in which you believe the company is sound and the stock has been dragged down by market forces only. So you decide wait until the market turns around. As we saw in the 2000-02 bear, that may take a long time. If you are determined to hold on to a losing stock, make a promise to yourself that if it drops another 25 per cent from its current level you will sell no matter what. At least you will get out before it falls to zero.
Sell if there is a change in the economic climate that works against the stock. Certain types of stocks perform better when the economy is strong and interest rates are rising. Others do well in slow-growth, low-rate environments. When you buy shares, find out whether the company is especially vulnerable to changes in the cycle.
This is particularly relevant right now. We are in a transition stage. The next few years should feature above-average economic growth, higher interest rates, and rising inflation. That’s a scenario that does not favour banks, utilities, real estate stocks, and companies that are highly leveraged. If you own shares in any of these sectors and are sitting on good gains, you might consider taking some of that money off the table.
Stocks that tend to perform well in high-growth conditions include those in the resources, transportation, and manufacturing sectors.
Sell if the stock is threatened with political action. Conservative leader Stephen Harper has said a government under his direction would cut subsidies to industry. Since we’re dealing with a minority Parliament and we could have an election within a year or two, that’s a plank in the Tory platform that is worth noting. Some publicly-traded companies (Bombardier comes immediately to mind) receive millions of dollars in government handouts. Such a policy shift would almost certainly have a negative impact on their bottom line.
Next page: Other times you should sell
Sell on unexpected and serious bad news. I never recommended Atlas Cold Storage Income Trust (TSX: FZR.UN) in any of my newsletters but I owned some shares in one of my portfolios. Last fall when the news broke that the trust was suspending distributions, terminating their CFO, and appointing a special committee to investigate the books, I sold my entire position immediately.
Fortunately, I was able to get out in the $12 range. Since then, the news has become progressively worse. In recent developments, the Ontario Securities Commission has accused four former Atlas executives of cooking the books from 2001 to mid-2003 (allegations which have yet to be proved) and a $350 million class action suit has been filed against the trust. The shares were recently trading at around $5.
There was a time when a sell-off on bad news was a signal to buy as the stock would almost certainly rebound, often sooner rather than later. But things are different now. We have seen too many cases in which bad news simply begets more bad news and the share price continues to spiral down. If it should happen to you, the best course is to get out with minimal losses while you can.
Sell when a stock’s market value exceeds 10 per cent of your portfolio. Sometimes we get lucky and a stock that we own explodes in price. It happened this year now with Research in Motion (TSX: RIM), which went from under $20 a share in mid-2003 the $95 range (split-adjusted) in early October.
If you’ve been a beneficiary of this remarkable recovery, congratulations! Now take a look at your portfolio and see how much RIM represents of its total value. An almost five-fold increase in a year may well have pushed its weighting over the 10 per cent mark. That’s too much to have tied up in a single asset, especially one with a volatile history. Proper diversification is one of the key strategies in risk reduction. So sell some of that RIM (or any other big gainer you own) to reduce the weighting to below 10 per cent. Spread the money around; there are always other opportunities available.
Of course, it goes without saying that before you sell anything in a non-registered portfolio you should consider the tax consequences. If you have to take a loss, make sure you have some capital gains against which to write them off, either from this year or previous years. If you’re going to take big profits and have no losses available (lucky you!) be sure to keep some of the proceeds in reserve in order to satisfy the demands of Canada Revenue next April.
That said, don’t let tax considerations deter you if circumstances dictate dumping a stock. Take the needed action and make provision for whatever tax consequences result. Just know what they will be.
Excepted from an article that originally appeared in The MoneyLetter, published by MPL Communications.