Knowing When to Sell a Stock

How to create an exit strategy for your investments

Subject: Jared Murphy

Breaking up is hard to do, especially when money is involved. But when Jared Murphy found his self-managed Roth IRA exposed to too many volatile stocks in the oil and gas sector, he decided the risk was more than he could tolerate. The 24-year-old sold his shares of ConocoPhillips (COP) in early March of this year.

“When I bought ConocoPhillips, I didn’t feel it was as good of a value as I would have liked it to have been,” says Murphy, who bought the stock at around $66 per share in December of 2010. He sold at about $77 a share. “I believe my other exposures to oil and gas will provide a better risk-return.” About 18% of his portfolio is in the energy sector.

Knowing when to part with an asset is essential to any successful investing strategy. In the last few months, natural disasters and political unrest have caused a surge in market volatility. These ups and downs may cause even the most confident investor to act out of emotion. Indeed, those nervous impulses were evident leading up to the March 2009 bottoming of the Dow. Investors withdrew a total of $225 billion from U.S. based mutual funds in 2008, according to TrimTabs Investment Research. Considering that the market has risen some 80% since spring of 2009, many investors may have pulled out too soon.

A sound plan of attack can help stem emotional waves and grow returns. Clear understanding of your present financial picture and future goals should determine how you manage your options, says Imari Love, equity research analyst at Morningstar.

Building the Foundation
Murphy began building his nest egg while he was in college. With a significant time horizon, and an aggressive agenda, he opted for a portfolio comprised solely of equities. He says the portfolio yields an 8% to 10% return annually. While Murphy may have a greater risk tolerance than the average investor, given his longer time horizon, he still likes to be strategic about managing his risk.

“When you find an investment option that meets your needs, research it, evaluate it relative to all your other investment options, and invest in the one that gives you the most attractive profile,” says Love. The same process holds for developing an exit strategy. “One of the reasons someone would sell is because the company-specific reasons you bought the stock either have changed or never materialized,” he explains.

No Sudden Moves

With escalating unrest in the Middle East, Japan recovering from the deadly tsunami and earthquake, high U.S. unemployment, and a housing crisis, investors are skittish. While broader market events can have a tremendous impact on a stock’s price point, Love says you need to determine whether the stock’s price is falling because it’s moving in sympathy with the rest of the market or because the company’s business has fundamentally changed in some way. Research all the factors that made you believe it was attractive in the first place—revenue structure, market positioning, innovation, management team, target returns, etc.—and take note of any changes. To guard against major surprises and disappointments, diversification is key, says Jesse Abercrombie, financial adviser at Edward Jones Investments. “Keep each stock to less than 5% of your equity portfolio. When it exceeds 5% it may be time to sell it,” he adds.

A shift in competitive landscape or a flaw in the key themes you built your investment case around can all be causes for concern and a reason to sell your stake. But sometimes, your relationship has matured and reached its maximum potential. “Ultimately, whenever you enter into a stock with a long position, you should be doing so because you believe it to be priced lower than what it’s worth,” says Love. “Once it reaches [a level of appropriate value], never be ashamed of taking a profit.”

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