Part Two: How do I know when to sell a share?
Yesterday I answered three of the four questions. I left the final question as a separate topic because it requires more thought and different reasons why you might sell an investment. In February 2020 I wrote a six-part series about possible scenarios where you might want to sell an investment. This applies primarily to stocks. Stock ETFs can be sold, but rarely do I sell them.
When to Sell ETFs
The nice thing about ETFs is that you have less to worry about. Generally speaking, if you buy shares of a good ETF, don’t sell them. Individual stocks, however, are a different story. I will give some stock and ETF examples.
Rule Number One: Dividend is Cut or Suspended
If a company’s board of directors reduces the dividend, this is generally a bad sign. If you pick quality investments, this might never happen. However, during the recent Covid-19 pandemic, many businesses that depend on travel and entertainment had no customers. They might have been paying a dividend before the pandemic growled, but if the company (Examples: hotels, office real estate, airlines, cruise lines, and movie theatres) has no income, then they are wise to cut the dividend. I had a few of these, and I sold them. Sometimes it makes sense to break this rule. For example, Ford (ticker = F) suspended their dividend. I did not believe the risk was as great for Ford, so I did not sell. Rather, I bought more shares as the price dropped.
The Ford Escape, however, is one of my favorite SUV’s. The risk we have when we have a favorite is that we get an emotional attachment to it. It is never a good idea to fall in love with a company or a stock. Know how much risk you may face.
Rule Number Two: Watch for Large Price Increases
Over time, even if you carefully selected a broad mix of funds or individual stocks, it is likely several of them will eventually represent a much larger portion of your total invested dollars. Therefore, my rule is that I will never hold more than 5% of my total invested dollars in a single company’s stock. So, if the value of a stock investment goes up faster than the other investments, I will often sell a portion to lock in profits and to avoid having too many eggs in one basket.
Sometimes an investment increases quickly by 10-40% or more. When that happens, it might be wise to sell your shares and use the profits to buy a different investment. In your UTMA account, your shares of the ETF FTEC (Fidelity MSCI Information Technology Index ETF) grew much faster than the other funds. I did not sell all of your FTEC shares, but I sold a portion so that I could reduce your exposure to this one sector. This made it possible to buy other investments with growth potential. If you have $2,000, that means you probably shouldn’t invest more than $100 in shares of Ford. If your shares gained value and were worth $200, you might want to sell some of them. Your shares increased in value by 100% if this happens.
Rule Number Three: Competition is Eating Your Lunch
The third factor is a bit more difficult to determine. The third rule focuses on competition and outside forces. It is best to sell before other investors panic and sell. If there are more sellers than buyers, the price of your shares may drop very quickly and be worth less than you paid for them.
Ask the question, “has competition or any noticeable outside force altered the investment landscape?” Are other companies invading your customer base? For example, I would not want to buy a coal company given the transition away from that energy source. If I owned coal company shares, I would sell them. I am very hesitant to purchase Coca Cola® (KO) or Pepsi (PEP) stock due to the increasing sentiment against soft drinks and junk food. Competition can dramatically impact a business. Blackberry was the phone of choice when I was at Conney Safety Products (BB – BlackBerry Limited). But it wasn’t long before Apple’s iPhone and other smartphones with wonderful apps and without a clumsy keypad ate Blackberry’s lunch and dinner. Cameras have also seen revolutionary change, so film companies like Kodak suffered. Watch for changes in technology and consumer preferences. (KODK – Eastman Kodak Company).
Rule Number Four: Your Company is Being Purchased by Another Company
Sometimes a big fish swallows a smaller fish. Sometimes a big company gobbles up a smaller company. If you own shares in the smaller company, most of the time you will be very happy. Rule 4 requires more thought, but when this event happens, I usually sell. The rule is related to the future of the company after being acquired. If the company is going to be acquired, the price per share of the company often goes up in expectation of the completion of the sale.
However, if the proposed acquisition goes sour, the price could once again plummet. If there are doubts about what might happen, I think it is best to sell. Of course, the price of the shares could go even higher too. Imagine what would happen if General Motors tried to buy Ford and you owned shares of Ford? It isn’t likely that GM would buy Ford, but there would be a lot of buyers and sellers!
Rule Number Five: Divestiture or Spin-off of a Part of a Company
Rule 5 is related to Rule 4. The issue is related to divestitures. “If a company announces plans to split itself or spin off a separate company, then I am a bit skeptical.” The question to ask is, “Why are they selling?” If they acquired a business and are now selling it, I want to know who decided to buy it in the first place. Did a new management team look at the total business and do they have a plan for how to grow the remaining business? Are profits declining? Is the company losing market share? How does this benefit the shareholders?
Rule Number Six: Panic Selling
If you didn’t notice it, none of the first five rules are based on emotions. The last rule applies to all investments. It is especially needful to remember rule six when the market reacts strongly to negative news like the coronavirus. Sometimes The Dow Jones Industrial Average goes down more than 3% in a single day. The same is true of the S&P 500, which is an index made up of large cap company stocks. Fear and uncertainty caused dramatic selling pressure. Don’t panic sell. I repeat, don’t panic. What did I do when Covid-19 hit? I did not sell in a panic. I stuck to my rules.
If you buy good dividend-paying stocks and ETFs and especially good stocks with growing dividends, those who own them don’t rush to sell. Furthermore, those boring dividend-paying stocks tend to weather a crisis better than the stocks of companies that don’t pay a dividend. Patience, not panic, is the best approach. Panic selling is dumb.
Buy quality investments. Think long-term. Use the dividend income to buy more investments. Buy when everyone else is panic selling. Don’t panic.