4 Reasons To Sell A Stock (9 Reasons Not To)

When I first started investing, I was focused on one primary objective – finding stocks to buy. I quickly discovered that finding stocks to buy is part 1 of the process. Part 2 is determining when to buy.

This is the primary focus of all beginner investors…at first. After all, the objective of investing is to buy low and sell high. Sounds pretty simple, right? Not so fast. Knowing when to sell a stock may be more difficult than knowing when (and what) to buy.

What was your reasoning for buying the stock in the first place? It was probably because you expected the share price to go up, so one primary reason. But there may be numerous reasons to consider selling a stock.

In this article, I’ll review 4 reasons to sell a stock, and why you need to know when you’re getting out long before you get in. But before jumping in, let’s consider what may be the most important question to ask yourself before buying.

Your Stock vs S&P 500 Index

“Over the next 5+ years, does this stock have a high probability of beating the S&P 500 index?”

This may be the single most important question to ask yourself before purchasing a stock. I explain why here.

Did you know that over a 15+ year period, 90% of actively-managed funds don’t beat the S&P 500 index? That’s a dismal scorecard.

So, if you’re not confident your stock will handily beat the market over the long-term, why take the chance? Wouldn’t it be more sensible to buy the index?

As investors, it’s easy to get distracted by the near term:

• We’re in a recession, should I sell?
• Interest rates are on the rise, should I be in bonds?
• The Consumer Price Index (CPI) won’t roll over, what does that mean for the consumer?
• Retail sales numbers are down, uh oh!

These are valid concerns, and I don’t mean to minimize them. But they are a distraction for buy-and-hold investors with a long-term horizon.

I encourage you to think about investments in comparison to the S&P 500 index, which is your primary investing opponent. If you can’t build a thesis for your stock beating the index, you may be better off joining the market.

Before You Buy

I’m of the belief that when you buy a stock, you’re buying an ownership stake in a real business. This has been Warren Buffett’s approach to investing and it has served him, and many others, quite well. As the saying goes, if it ain’t broke don’t fix it.

Then there are those like Jim Cramer who believe a stock represents nothing more than a sheet of paper. These types of investors typically trade on sentiment, macroeconomics and press releases.

The big difference between Warren Buffet and Jim Cramer, other than billions in net worth, may be whittled down to speculation. Jim Cramer speculates on stocks based on hope. Warren Buffett speculates on stocks based on conviction.

Before buying a stock, you need to build conviction in the business the stock represents. Conviction isn’t built by reading a Tweet or watching Squawk on the Street. Nor is it built by watching the 50-day simple moving average on a chart.

Conviction is built through the work you put into understanding the business, its risks, mission, leadership and much more. There’s no secret recipe, and the process may differ for each individual.

Here are a few things I do to help build conviction (or lack thereof) in a stock:

• Analyze the Income Statement, Balance Sheet and Cashflow Statement
• Read the latest quarterly (10Q) and annual (10K) reports
• Scour the company’s Investor Relations website
• Listen to the latest earnings conference calls
• Purchase or consume the company’s product
• Assess major risks to the business and what may cause it to go bankrupt
• Perform valuation analysis to determine a fair price

This isn’t a comprehensive list of all things an investor can do to build conviction, but it’s a good start.

4 Reasons To Sell A Stock

The difficult thing about selling is determining when you’re going to sell even before you’ve bought. Admittedly, there was a time in my life when I traded in stocks more like Jim Cramer. After I came to my senses and began investing more on knowledge than hope, I discovered I was holding stocks in which I had no idea:

1. What the fair value was
2. What the risks were to the business
3. What the financial statements looked like
4. Why I was even in it in the first place

If you find yourself in this situation, my advice is to build conviction quickly. Or simply sell the stock.

After learning from my mistakes, I now consider these 4 reasons to sell before I’ve even clicked “Buy.”

#1: The Stock Price Reaches Your Target Price

This is every investor’s favorite reason to sell a stock. The investment worked out as expected, reaching your target price and triggering a sell. There’s something quite gratifying when it all goes as planned.

But there’s a caveat. Before opening up the position, did you determine a target price? And I’m not talking about the Analyst’s target price you see posted on the stock page of Yahoo Finance. If you listen to those guys, every stock will double in the next 12 months.

This is where the “Before You Buy” section comes into play. Specifically, you need to understand future revenue and earnings growth as well as margins – gross, operating, net and free cash flow. Hint – looking to the past is a great way to inform the future (these tools can help you get started).

Next up is valuation analysis. This may include the market multiple approach and/or discounted cashflow (DCF) approach. I won’t go into detail here so as to not bore you further, but if you’re not familiar with these, I suggest you do some homework.

Unless you’re lucky, it’ll probably take a few years for the stock to reach your target price. If it does, perform the analysis all over again to determine if the stock still represents a market-beating investment. If it doesn’t, sell the stock with no regrets.

And don’t kick yourself if the stock goes up another 10% or 20% a month later. You made your sell decision based on facts, realistic assumptions and data. Aim to find satisfaction in that and don’t dwell on what could have been.

#2: The Investment Thesis Changes For The Negative

There will be times when you’ve done the homework and built strong conviction, but the company (or competition) throws you a curveball. This may change the investment thesis altogether, and negate what was once believed to be a market-beating investment.

A change to the investment thesis could come in many forms. Perhaps the company takes on a lot of debt to acquire a company you’re not a fan of. Or begins heavily diluting shareholders through stock-based compensation (SBC) or secondary offerings.

Maybe you can’t get on board with Mark Zuckerberg pivoting Meta (formerly Facebook) to focus on the metaverse. Or you’re uncertain how the rise of electric vehicles may impact automotive retailers such as AutoZone and Advance Auto Parts.

The list of reasons is almost endless. This is why it’s important to keep tabs on your investments over time. You’ll want to understand if the company pivots in a direction you’re unable to support. And to make a determination if the change in priorities warrants selling the stock.

#3: You Find A Better Opportunity

We’ve discussed how you should think about stocks in comparison to the S&P 500 index. But when it comes to new stock ideas, you should think about those in comparison to your existing holdings.

I’m always on the hunt for new stocks to buy. I enjoy the process. It’s sort of like hunting for eggs on Easter morning coupled with opening gifts on Christmas Day. I recently discovered international markets which opened up even more opportunity.

When I discover a stock with strong prospects, I compare it against my current holdings to determine if I should swap one for the other. Many factors go into the decision, including risk, position sizing and return potential, to name a few.

Finding a better opportunity may not mean in stocks. Perhaps you’ve come across a gem of an investment property. Or want to invest in a local business or startup. These too may be reason enough to sell a stock in pursuit of greater reward.

#4: You Need The Money Now

I’m a firm believer you should only invest money you don’t anticipate needing within the next year or more. But life happens. This could come in the form of job loss, health setback, caring for elderly parents, you name it.

This reason to sell is pretty self-explanatory. If your life circumstances change, and you’re in need of money now, sell your stocks. Or at least sell whatever portion you need to get by.

Don’t worry that your stock is down big and you’ll be locking in a realized loss. Do what’s needed to take care of yourself and family.

9 Reasons Not To Sell

Maybe just as importantly as knowing when to sell a stock is knowing when not to. Investing is an emotional game. It’s difficult not to get sucked into the news of the day, especially when the bear market is roaring.

If none of the 4 reasons above have been triggered, here’s a quick list of 9 reasons not to sell when the going gets tough:

1. You’re down a specific percentage below your purchase price
2. Technical indicators, such as moving averages and chart patterns, are not in your favor
3. Analysts downgrade the stock to sell
4. Short interest on the stock is rising
5. Financial pundits and talking heads say to sell
6. The Fed is raising interest rates
7. The economy is in or headed for a recession
8. Inflationary numbers are high
9. You’re timing the market (i.e. you think it has peaked)

These are a stock trader’s reasons for selling. A buy-and-hold investor will do well to ignore these “sell” signals, especially in times of fear.

Bottom Line

I’ll end the article with another great quote from Warren Buffett:

In a perfect world, you’ll never need to sell a stock. But the world isn’t always perfect, and the market isn’t always rational. Save yourself the headache. Be sure to identify when you’ll get out of a stock before you find yourself already in it.