Know When to Sell a Stock

Don't let a stock's stumbles blind you to its long-term potential.

"I love Facebook,” Will Danoff, Fidelity Contrafund’s excellent manager, said at a recent investing conference. “Don’t sell after the first double.” The advice resonated with me, and not just because I, too, own Facebook (symbol FB). I thought it helped explain why Danoff, a value-conscious growth investor, has been so successful. Like Warren Buffett, he has a strong bias toward holding a stock even when it encounters turbulence. “I don’t want to get shaken out of a stock if I like the long-term story,” Danoff once said.

Too many of us have subconscious sell rules that hurt our results. For instance, we often sell because of recent moves in a stock’s price. In 2000, I showed my investing genius by buying health insurer Humana (HUM) at $6. The stock now trades at $188, and Aetna has agreed to buy Humana for $230 per share. But I never brag about my coup because I sold Humana at $15 two years after I bought it. (Current prices are as of July 2.)

In selling Humana way too soon, I focused far too much on the stock’s performance (heroic), my holding period (long enough to qualify for favorable capital-gains tax treatment) and my ego (I was a proud seller). We all know people who think a loss isn’t a loss until you take it. Others, channeling my Humana experience, believe a profit isn’t real until you ring the register. A rational long-term investor such as Charlie Munger, Berkshire Hathaway’s vice chairman, would say that when it comes to making a sell decision, both views are equally delusional.

I invested in Buffalo Wild Wings (BWLD), a thriving sports-bar franchise, a week after it went public in 2003. A few months later, I freaked out when the firm said rising chicken wing prices would clip earnings. So, like a chicken, I sold and took my 30% profit. The stock has since risen more than 10-fold. The temporary commodity spike blinded me to Wild Wings’ long-term growth potential. Such price fluctuations are inevitable and are usually meaningless.

But sometimes there are better reasons to sour on a stock. I invested in Constellium NV (CSTM), a Netherlands-based fabricator of aluminum products, in early 2014 at $23. I was sitting on a nice profit when I read in August 2014 that Alcoa (AA) would compete against Constellium by getting into the aircraft-engine-parts business. Then Constellium reported punk earnings and gave a bleak forecast about future results. I sold at $29 a share. Since then, every earnings report has been catastrophic, and the stock now sells for $11.

Focus on the call. Sometimes a single earnings call should prompt a sale. I bought UCP (UCP), a land-rich home builder, in March 2014 at $14. The premise: UCP would sell to developers some parcels of land it had acquired cheaply and build some homes itself. But on its May 2014 call with analysts and investors following the release of first-quarter results, UCP said it had sold just $200,000 worth of land—down a staggering 97% from the same quarter in 2013—and exactly 52 homes on the 7,931 lots it controlled. On the call, executives sounded like a group of stoners. “Hey, man, we’ll get around to building the homes someday. You investors just need to chill,” they might as well have said. Not feeling mellow, I sold the next day for $13, taking a small loss. The shares now fetch just under $8.

Reviewing past sell decisions has led me to three new rules. First, if a company has a real business with great growth potential, you should cut it some slack. Second, always check to see if powerful emotions are trampling logic. And finally, if a company is floundering while most of its peers are prospering, acknowledge that you have a lemon and don’t try to make lemonade out of it. Toss it in the trash.

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