The Art of Selling Stocks
If you had bought Whole Foods at the start of 2000 and held on, you would have made eight times your original investment. But you would have been sorely tempted to sell — perhaps at $80 in 2005 (take profits!) or at $10 in early 2009 (bail out!). In fact, the smart play with Whole Foods — as with any company you love — is to buy and to keep buying, using a system of dollar-cost averaging. In other words, buy however many shares a specific dollar amount (say, $1,000) will purchase every quarter or year.
Will a time come when you should sell Whole Foods? Possibly. John Mackey, the 59-year-old founder and longtime CEO, will retire someday. When he does, I would closely scrutinize his successor, although I would not sell immediately. I would also worry if any CEO, Mackey included, decided to take Whole Foods in the wrong direction — opening a chain of organic restaurants, for instance. And I would worry if a rival began to outsmart the incumbent.
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What I am not worried about is share price. Yes, Whole Foods appears expensive. The stock sells for 31 times estimated earnings for the current fiscal year. But according to the Value Line Investment Survey, Whole Foods' price-earnings ratio is usually twice the overall stock market's. And for good reason: Analysts, on average, predict that earnings per share will grow a stellar 17% annually over the next three to five years. Plus, the upscale grocer boasts a pristine balance sheet, with $1.2 billion in cash in the till and just $24 million in debt.
By contrast, consider Hewlett-Packard (HPQ), a company that could not adapt to shifting competitive forces in its main business, personal computing. One danger sign was that a succession of CEOs could not revive the company's profits. Another was a series of scandals. Do not hesitate to sell if you believe a company's management is cheating in any way. HP also provides a good example of the risks of investing in industries in which dramatic change is the norm. Groceries are safer. (For more on HP, see How to Avoid the Next Hewlett-Packard).
Sell for balance. There are two, and only two, reasons to sell a stock if a company is doing well. The first is for diversification. Imagine you have made eight times your original investment in Whole Foods and, as a result, it now accounts for half of your portfolio. Holding such a lopsided mix is asking for trouble, as investors in Enron know. Disaster can strike a company at any time. Smart investors rebalance annually. If you own 20 stocks, they don't each have to represent 5% of your holdings, but none should probably be more than 15%. Rebalancing is a good, emotionless way to trim holdings of a stock whose price is soaring. During the tech bubble of the late 1990s, for instance, rebalancing would have helped you avoid having too much of your portfolio in overpriced Internet stocks.
Sell because you have to. Or want to. The second reason to sell is because you need the money. Don't forget that the objective of investing is to provide the resources for you and your family to live a good life. At some point, you'll want to turn your partnership with a great business into cash that can be used to buy a house, pay for a college education or keep you comfortable in retirement. When you reach that point, sell without regret. Saving for goals such as these is why you own stocks in the first place.
James K. Glassman is founding executive director of the George W. Bush Institute and author of Safety Net: The Strategy for De-Risking Your Investments in a Time of Turbulence. He owns none of the stocks mentioned.