When to Sell a Stock

How do you make the decision to take profits, or cut a loss?

Take Amazon and Microsoft as two examples.

Amazon crashed by 95% after the millennium stock market peak, but has since the low of 28 cents in September 2001 increased by over 600 times. Had you invested $5k when tech blood was flowing in the streets of Silicon Valley you would have a nice, cool 3 million USD now. Typically, however, most people bought close to the peak and sold close to the bottom – that’s how peaks and troughs are created.

 

The most important thing is knowing when to sell a stock.

People who now wished they bought Amazon at 10 cents around the IPO in 1997, would most likely have bought much more in 1999 at about $5-5.50 and given up and sold out with a huge loss at 28 cents. You can actually tell from charts over Amazon’s share trading volumes between 1999 and 2002.

Recently, the stock dropped by more than half in 2022. Should you have sold, could you plausibly have sold, at the peak slightly below $190 and bought twice as many shares for the same money at $81 a year later? Would it have been reasonable to try to sell Amazon in the hope of a pullback. What would the intelligent investor have done? What would Warren Buffet and his investment company Berkshire Hathaway have done? Actually, Buffett is a poor example in this case since he stays away from anything categorized as tech or exhibits high valuation multiples…. except for Apple. But what should an informed value-oriented investor have done with Amazon’s stock?

Or Microsoft?

It was still 9 years later down by 75% from its 2000 peak. Would you have had the patience to still hold it after that? Should you have?

Or Apple for that matter?

Apple’s stock increased by 1000% (!) in the late 1980s, then gave almost all that back between 1991 and 1997. Then rallied by over 1000% again the ensuing few years only to give most of that back again (-82% over just 9 months in the year 2000). It also crashed by 62% in the 2008 stock market rout. But overall it’s of course been a tremendous investment. At the current price of $184 it has appreciated over 3500 times since 1987 (not counting dividends), making that hypothetical $5k into about $18.5 million.

To time both buying and selling shares you need to consider the valuation as well as what other investors are likely to do. The latter part is much more important in the short run, but over time it’s best to only buy stocks that are valued low relative to their likely future cash flow generation. We can’t know how profitable a company will become or stay, but we can make educated guesses which is what I show how to do in The Investing Course, as well as how to better time an investment and optimize a portfolio of assets.

 

It would obviously have been profitable to sell Amazon at the 1999-2000 or 2022 peaks, but only if you managed to buy it back at lower prices before surging again. But should you have attempted it? Is it worth the risk of not getting back in again?

Some say you should sell a stock if you wouldn’t have bought it right now. That’s simplifying things too much. You should only sell if you have better uses for the money, for example another stock with significantly better prospects (valuation and trend). Or if you think cash will perform better. Most of the time the trend is your friend in investing, so even if the stock you’re holding is becoming a little overextended, a little expensive rather than cheap or fairly valued, it often pays off to keep holding it until the trend turns down.

Companies in a good trend tend to both attract more investors and keep rising, and surprise positively in their fundamentals, thus making the stock grow into its valuation. Amazon is a great example of that – it has always seemed expensive on traditional valuation metrics, but it has kept growing and the stock price with it. It still can seem expensive at 58 times earnings and 3 times revenues, especially compared to the long term warranted overall stock market valuation of 15 times earnings and 1 time revenues. However, the Amazon stock is likely to keep attracting investment flows, and on top of that the company just might add new revenue sources as well as increase its margins and thus boost earnings significantly. Well, I still think it is a bit too expensive for my personal taste, but if I held the stock tight now I would have held on to most of it anyway, since the trend for the Mag-7 stocks including Amazon is so strong.

 

So, when should you sell a stock?

When you need the money. When you have better use for the capital, like in a stock that is considerably cheaper and exhibiting a good price pattern. Or if the stock is ‘obviously’ way too expensive, and for example has risen in a parabolic fashion with no basis in fundamentals. How would you know that? Could you have seen it coming back in 2000? Well I and many others did. All tech stocks were overextended, as was the overall market. On the other hand, did I buy Amazon at its lows that followed? Nope, I missed out.

 

Nothing is obvious on the stock market, due to its dynamic reflexivity (see Soros, Alchemy), neither buying, nor selling. The market’s very function is to balance obvious reasons to buy with obvious reasons to sell.

 

In any case, I think a good rule of thumb for selling is when a stock has quickly for no apparent fundamental reason become around 30% overvalued vs. your assessment of its true fundamental value. That’s a good 2 year’s worth of normal individual stock returns. Use the money to buy something on your short list of investment prospects, or just sit on the cash for a while to see if any opportunities materialize – maybe even in the stock you just sold.

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