How to Break Up With Your Stock
Why would you kick a stock to the curb? You first need to remember why you bought it in the first place.
You’ve had some good times together. You’ve had some bad times. Now you have to decide if it’s time for your stock to start seeing other people. Selling isn’t easy, especially if you’ve been together for a long time.
The best reason to sell a stock is that it’s no longer doing what you bought it to do, such as deliver increasing levels of sales and earnings. “You won’t know when to sell unless you’ve come up with a sell plan before you buy,” says Stephen DuFour, manager of Fidelity Focused Stock Fund.
If a stock you bought for its growth prospects misses Wall Street earnings expectations, for example, you should keep your eye on it—but you probably shouldn’t push the sell button right away. If that stock suffers a string of quarterly misses, send it to Palookaville. Kraft Heinz saw its earnings fall for three quarters before posting a stunning $12.61 billion loss for 2018 in February.
Don’t hesitate to look at analysts’ research, often available free from your brokerage, as you try to figure out what’s wrong. “It could be a structural problem with the company, and that’s where you should rely on others to help you,” says Randy Frederick, a vice president at the Schwab Center for Financial Research. The stock’s price moves might also give you some hints. If it falls below its average price for the past 50 days, for example, then other investors are having doubts about the stock, too, and it’s time to look for a reason (see The Magic of Moving Averages).
The main concern for income investors should be that a stock continues to pay dividends—and, preferably, boosts them regularly. One red flag is a dividend yield that is several percentage points above that of similar stocks, which happens more often because of a sinking stock price than increasing corporate generosity.
But if the company has enough money to continue paying the dividend from earnings—and not by borrowing—then keep the stock. The dividend payout ratio, calculated by dividing dividends per share by earnings per share, is a quick test to see if a firm can afford its payout. A rule of thumb says a payout ratio above 55% is a red flag, but payout ratios vary by industry, so it’s key to compare your stock’s ratio with other stocks in the same industry.
Too much of a good thing. Another good reason to sell a stock is if it appreciates so much that it becomes too big a piece of your portfolio. That’s particularly true if you get stock as part of your compensation. Then you’re putting both your investment capital and your human capital (your job) in your company’s hands.
Some investors set a limit on how big a part of their portfolio any stock should be. Fidelity’s DuFour tries not to let any stock count for more than 5% of assets. Tom Plumb, manager of Plumb Equity Fund, starts to get uncomfortable when a stock gets to 10% of the portfolio. You should certainly consider trimming back a stock that is more than 15% of your holdings. Rebalancing, or selling shares of your winners and investing the proceeds in your laggards, is a simple way to reduce overly appreciated positions.
Try to resist the urge to dump a stock if it hits the headlines for the wrong reason. Often, that’s a good time to buy, not sell. Nike’s stock teetered, then snapped back, after Duke University’s Zion Williamson’s shoe fell apart during a critical basketball game. Boeing’s woes are far more serious—more than 300 people have died in two crashes of its 737 Max since October. The cost to Boeing could reach into the billions. If you own shares, hang on; new buyers should wait for more clarity.
If a stock runs up after you sell or trim it, you’ll feel like a clod. Don’t. If you trimmed an outsize holding, you reduced your risk. If you take a loss when you sell, you’ll get some consolation from the tax man. You can use your losses to offset capital gains in other holdings. And if you sell at a profit and have to pay capital gains taxes, don’t complain—it’s a sign you’re doing something right.