When to Sell a Stock?

I´ve received several emails regarding price and sell targets since several of the picks on this site have appreciated significantly (particularly IIP since the company´s recent earnings report just last week). This post summarizes our sell discipline.

First of all, we are not traders and as such, in most instances, we are looking for the benefits of long-term capital appreciation, which we define as a minimum one-year holding period, and no maximum holding period (i.e. we´ve been holding some positions for over five years already). Incidentally, the main benefit of investing in stocks, disregarding for the moment IRA´s or other tax-deferred accounts, is the favorable tax treatment you receive for holding stocks for one or more years.

With that said, listed below are the only three reasons why we would sell a stock in under a year:

I. Business Fundamentals Have Changed for the Worse
If we feel that business conditions are going to deteriorate for a company, such that the company´s cash-flow will begin to decline significantly then we´ll sell the stock. Conversely, there is almost never an instance why we would sell a stock in a company with improving business fundamentals. It  is important to ignore the daily fluctuations in stocks and instead focus on the business fundamentals. If the business is good, and can expected to be so for quite some time, just hold on to the stock. Don´t worry about selling at the high and then buying it back on dips. Don´t worry about the technicals, 50-Day Moving averages etc. Such a trading mentality will keep you from recognizing the truly great capital gains that stocks can provide. It can also drive you mad following all the price movements, almost all of which, on a daily basis at least, are simply "noise."

II. The Stock is Significantly Overvalued.
At times, some stocks can become significantly overvalued, whereby the valuation of the company has little correlation to potential future cash-flows even assuming best case scenarios. In these instances, we´ll sell the stock.

III. The Money Invested in this Stock is Needed For Other Investments or Purposes
This is a somewhat obvious criteria. If we need the money for other more attractive investments or for other personal or business purposes then we´ll sell the stock.

Just as an example, we sold GHM (a cyclical company) after a 10 month holding period, because we thought the stock at $21 could not go much higher even assuming best case scenarios for this up cycle. Also, we needed the money for more attractive investments with better risk/reward ratios. As regards to IIP, the business outlook for this company is solid, so I don´t forsee selling this stock for quite some time. In addition, as mentioned several times in the past, there is a ton of business value still to be realized from IIP. If management can unlock this value, the stock will move higher. Only time will tell.  The recent rise in IIP, merely reflects renewed optimism about the company (heck the EBITDA growth in 2006 will be fantastic), but of course there is still alot of work to be done at the company. I´d only seriously consider a new evaluation of the company after the next earnings report. Until then we´re sitting on our hands.

That said, we´re getting killed on RBAK today. Should we have sold at $22. Perhaps. Only time will tell. For now, we´re content to have bought this stock at $10 and we´ll ride it out for as long as the company´s business fundamentals remain strong (and 2006 promises to be a great year for RBAK). We can´t begin to tell you how many harrowing dips, we´ve faced in stocks over the years, only to see the stock reverse quickly and double again. All in all, if the business is doing well, the outlook is good, and the stock is not way overvalued, there is never a reason to sell the stock. That´s our opinion.