When to Sell A Stock?

A few high-flying growth stocks came crashing back to earth after posting poor earnings. Facebook fell 21%, Netflix dropped 19%, and Twitter cratered 27%.  In the days leading up to the Facebook announcement, it rose 4.5% to close at an all-time high of $218.62. If investors knew it was going to collapse, they would’ve shorted the stock or bought puts to profit from the drop.

Facebook went public in May 2012 at $38 per share. It has returned 354% for investors, or 27.5% per year from its initial public offering. However, after a few days of trading it fell 25% and by Labor Day it had dropped more than 50%. In Fact, Barron’s Magazine gave it a thumb’s down in their September 24, 2012 issue with a price target of $15.[1] It never hit $15 per share and since the article appeared Facebook has risen 1,050%!

Facebook has had double digit losses in each year it has been a publicly traded company. If you sold it on every wiggle, twitch, or flutter, you’d never make any money. A buy and hold investor has probably made the most money in this stock if she’s been able to ignore the volatility.

As a stock gyrates, how do you know if it’s the beginning of the end or a temporary pause in an upward trend? How do you know when it’s the right time to sell?  Here are a few suggestions.

Allocation. If your single stock holding is more than 25% of your portfolio, it’s a good time to sell and diversify your assets. A 3% to 5% allocation to a single stock is recommended.

Price Target. If your stock hits your pre-determined price target, take your gain. If you buy a company at $15 per share with a price target of $20, take your profits if it trades to your mark.

Ratios. A rising stock is fun to own. As it climbs, keep an eye on the key ratios like price to earnings, price to sales, and price to book. The higher the level of the ratios, the lower the future performance of your stock may be. Comparing current and historical ratios is advised. You can view this data in Morningstar, Value Line, or Yahoo! Finance.  Netflix stock price soared 126% in less than a year and despite the recent 20% drop, it still trades at a price to earnings ratio of 125, well above historical norms.

Balance Sheet.  A company with negative cash flows or high debt levels should be avoided. If it’s cutting or eliminating its dividend, it’s a good candidate to sell. Tesla has been a polarizing stock for a decade and since 2008 it has had (growing) negative cash flows.

Goals. Your financial goals may change over time. If your account value has increased and you want to preserve your assets, sell some of your stock holdings and buy bonds. This will reduce your stock exposure and risk level.

Taxes. If you have realized gains, sell stocks with a loss to offset the gains. If you have realized losses, take gains. You can offset gains and losses dollar for dollar.

Timing. Selling a stock at an all-time high is always preferred. However, it’s better to buy at the right price, but this is hard to do because the stock is probably in a slumber or hitting new lows. The best time to have bought Facebook was September 4, 2012 at $17.73 after it had fallen 53%. Obvious today, but it would’ve been a difficult purchase at the time because it was engulfed in negative news as evident by the Barron’s article. It was also a new platform not known to many. If you have the courage to buy a stock that everyone hates, you may be rewarded over time.

A strategy I recommend is to purchase a basket of low-cost mutual funds giving you exposure to thousands of companies. A globally diversified portfolio of mutual funds will free you from making any buy and sell decisions allowing you to focus on your long-term goals.

You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in the markets. ~ Peter Lynch


August 1, 2018

Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. Please consult your CPA or tax advisor before implementing any of these strategies to see if it makes sense for your situation.

[1] https://www.barrons.com/articles/SB50001424053111904706204578002652028814658, Andrew Bary, 9/24/2012.