Know when to buy 'em and when to fold 'em

Selling: Doing it wisely usually increases the profit or decreases the loss on a stock holding.

Dollars & Sense

October 03, 1999|By William Patalon III | William Patalon III,SUN STAFF

On the investing gridiron, when you sell can be as important as what and when you buy.

When it comes to stocks, investors too often spend most of their time tackling the "buying" portion of the investment equation: Deciding what to buy, when to buy it and what to pay.

Granted, it's crucial to buy smart. Unfortunately, too few investors understand that selling prudently can be how you score most of your points.

"The most frequent question we get is: `How do you know when to sell?' " said Ralph Seger, a personal finance writer and president of Seger-Elvekrog Inc., an investment adviser in Bloomfield Hills, Mich.

Broadly speaking, there are three reasons to sell an investment: To lock in profits on that long-awaited big gainer.

To manage risk and protect your capital, often by stopping small losses before they become big ones.

And -- for those who wish to minimize their annual gift to Uncle Sam -- to call your own game on taxes.

There's a fourth reason that can be crucial:

Sometimes, with a solid stock, the best time to sell is, well, never.

Shrewd selling demands foresight.

Indeed, jumping into an investment without first understanding when you might sell is tantamount to stepping onto the field against the swarming Penn State defense without scripting a game plan -- in either case, you risk being sacked for a loss. And while such an omission on the football field may bruise your body, this misfiring in the capital markets can savage your portfolio.

"It doesn't matter whether you're buying stocks for growth, or for speculation, so long as when you buy, you immediately devise an exit strategy" in case your strategy doesn't work, said Bill Bresnan, an author and New York City radio commentator who has been host of call-in shows for investors since 1982.

If you're among the befuddled, huddled masses, despair not -- many investing gurus will tell you that deciding when to sell is far tougher than knowing when to buy.

"Selling is an art, not a science," said Donald L. Cassidy, a senior analyst for financial-data firm Lipper Inc. and author of the book, "It's When You Sell That Counts."

But it's an art that individual investors can learn. And that education begins with a simple premise: Look at selling as the flip side of buying, said Seger.

This leads to a key rule: Consider selling an investment if the reason for buying it has changed. For instance, if you bought a stock because the firm is well-managed, and that exquisite suite of executives either loses its touch or declares free agency, consider selling.

Or if you purchased a company's shares because earnings advanced at a consistent 20 percent, and the growth rate stumbles to 9 percent, consider selling.

However, this guideline is but the kickoff for the detailed analysis that should go into deciding whether or not to punt a stock from your portfolio.

Many of today's ever-bullish investors equate selling only with "taking a profit," and not with cutting a loser. "Taking a profit" means transforming a gain that exists only on paper into real money by actually selling the stock.

But how much of a gain is enough?

An old Wall Street axiom holds that you should sell your losers and let your winners run. In general, that's good advice, since the profitable stocks are the ones that increase your portfolio's value. Losers bleed you dry.

And yet, too many investors do just the opposite, selling their winners while keeping their losers.

With some stocks the "buy-and-hold" strategy can generate greater gains than those notched by a halfback who breaks a tackle at his own 10-yard line. But you still need protection; even great companies fumble.

Investing veterans have several suggestions.

First, use price targets.

When analyzing a stock you intend to buy, calculate a reasonable time horizon and price objective for the shares. For instance, a $25 growth stock you think will advance 15 percent a year can be projected to double to $50 in five years.

Just because it hits your target doesn't mean the game is over for that stock. But it is time to re-evaluate. If the stock is at, or near, what you consider to be its fair value, sell it and draft a different stock.

If you honestly believe that more growth is likely, set a new price target and hold on. If the shares hit that new target, run through this drill anew.

Second, make sure you don't give back a good gain. If one of your winners starts to give ground, see if problems lurk.

Third, be alert for "outsized gains" -- that is, short-term gains far above anything warranted. For instance, if you buy a stock at $25 with the belief it will double in five years, and it doubles in two months, think about cashing out, experts say.

Deciding whether one of your stocks is overvalued requires study of a company's financial statements; the growth rates of its revenue and profit; and its profit margins, debt levels and share price in relation to all these financial factors.

However, that intensive exercise, known as "fundamental analysis," is something you already should have been through as part of your decision to buy the stock.

Go through this analysis again before selling a stock, even at a profit, since it's possible for a company's business to evolve faster than investors or Wall Street expect.

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