The Art of Selling Stocks
Successful stock investing requires two kinds of transactions: buying and selling. Unfortunately, nearly all advice givers, including me, concentrate on the first and leave you to fend for yourself on the second. So with this column I correct the omission and provide a set of rules about unloading shares.
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As a rule, you should buy stocks with the intention of holding them for a long, long time, meaning at least ten years and perhaps forever. The reason is simple: Deciding to buy something is hard enough, but deciding to sell is even harder. You have to know what to sell, when to sell and what to replace it with. Plus, once you own a stock, your emotions, not just your money, are invested in it. You may become reluctant to sell an overpriced winner that's lost its competitive edge because it has been so good to you. Or you may hesitate to dump a troubled loser because doing so would confirm your stupidity. So make limited buying decisions and hardly any selling decisions. As Warren Buffett once put it, "Inactivity strikes us as intelligent behavior."
Sell because something has changed for the worse. In Common Stocks and Uncommon Profits, one of the best investing books ever published, Philip Fisher wrote, "It is only occasionally that there is any reason for selling at all." That occasional reason is "the deterioration of a company's underlying business." In Fisher's view, there were only two possible causes of a deteriorating condition: bad management (which usually meant a change at the top wasn't working out) or decreased prospects for a company's products. As my wife is fond of saying, this seems to be an insight into the obvious.
But think about why most investors sell stocks: price. Either the price has gone up so much that it's time to take profits, or the price has gone down so much that it's time to cut losses.
In 1960, a professional dancer named Nicholas Darvas wrote a book called How I Made $2 Million in the Stock Market, which turned into one of the biggest financial bestsellers of all time. He preached the virtue of the stop-loss order — for example, buying Apple at $150 and telling your broker to sell automatically if the shares hit $120. That way, the most you could lose would be 20%. Selling at $120 as Apple continued to slide to $78 in January 2009 might have left you feeling pretty good at the time. Only problem is that today the stock sells for more than $400, and you don't own the best business in the world.
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My advice: If you own a good business, don't sell it. Let your three-baggers (stocks that have tripled) turn into ten-baggers. And if the price is falling, buy more shares.
To know when to sell, know why you bought. The reason to own a stock is that you want to become a partner in a great business. That's the formulation of Warren Buffett's mentor, Benjamin Graham, and it is the starting point of all market wisdom. But you need to know what makes a business great. If you do, it will be much easier for you to determine when the business is no longer great and it's time to sell the stock.
Let's take a close look at Whole Foods Market (symbol WFM) as an example. The stock ran up from $9 in 2000 to nearly $80 at the end of 2005, then skidded to $8 in November 2008. Today it trades at $91. In other words, Mr. Market has run hot and cold on Whole Foods, as he does on most stocks. But the logic behind buying into this company remains the same: It's a business with an inspirational leader and a clear, attractive, modern vision that sells, at premium prices, things that everyone needs to consume every day.
Over the years, Safeway, Wal-Mart and other competitors have entered the healthy-grocery space. Just visit those stores, however, and you'll see why they fall short. The Safeways and Wal-Marts try to do it all, whereas Whole Foods stores — where you can't buy Coke or Kleenex — differentiate the brand strongly. Whole Foods' approach pays off. Sales have risen from $9 billion in the September 2010 fiscal year to $11.7 billion in the year that ended last September. Meanwhile, earnings jumped 80%.