Warren Buffett says that the ideal investment is one that you can hold onto forever, growing your money for as long as you own it. However, Buffett and every other successful investor also knows that there are times when selling a stock is the best route.
For example, Phil Town was a big fan of IBM and bought into the company in his earlier investing years. He researched IBM thoroughly, and felt that he understood the business as if it were his own.
A few years later, IBM got a new CEO named Ginni Rometty. Phil believed that she was trying to change the direction of the company, and she did not have a proven track record of success in the technology field. This was a big red flag to Phil.
It was clear that IBM wasn’t making the transition to a new CEO smoothly, so Phil tried to offset IBM’s drops in the market by buying in on put options and selling on call options. This did not generate returns like he hoped it would.
Interestingly enough, while all of this was happening, IBM sustained a big Moat—which they still have today. This is a great indicator of how hard it is to break a big Moat, even when the company is seemingly doing everything wrong. But it takes much more than Moat to make a great company.
Ultimately, Phil ended up exiting his position with IBM, but was still able to profit off of it. This is the importance of buying companies with a Margin of Safety.
So, the question is: when IS it the right time to sell a stock? If you’ve done your homework and you’ve bought a great company at an attractive price...why sell it?
You don’t want to regret the feeling that you sold something too late or too soon.
You should sell a stock when the fundamentals of the company have changed. All companies change over time—sometimes for the better and sometimes for the worse.
New management sometimes takes over, new competition comes onto the market, and, sometimes, the entire story of the company itself may change. If the company you now own is no longer the same company that you first invested in and you no longer have faith in its new direction, it's a good time to sell your stock.
Second, you should sell a stock when the price of the company has reached its intrinsic value. As Rule #1 investors, we try to purchase companies at a discount to their true value. Thankfully, various events in the market can often drive the price of a company down below its true value, creating a great buying opportunity.
Last, it’s a good idea to exit your position in a company when you simply have a better opportunity. While it's always ideal to have cash set aside for use in case a great investment opportunity comes up, there may be times when you want to invest more than you have available in cash. In these situations, it's perfectly okay to sell a stock in order to free up capital.
In today’s podcast, Phil and Danielle talk about the changes in IBM that drove Phil’s decision to exit his position, and what investors can learn from them.
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