Thursday, August 26, 2010

When to Sell: Reasons to Sell that are Unrelated to the Stock

When should I sell stock I bought as an investment?

At heart, I’m a “dividend growth” investor. So, logically, when a stock ceases to be a dividend growth stock I should sell it. But, economic cycles and temporary misfortunes don’t necessarily turn a good company bad. So, under what conditions should I decide that a formerly good dividend growth stock has ceased to be one?

In my previous two posts I identified four analytical criteria and three qualitative reasons I’ll use to make that decision. But there are other reasons I‘ll consider selling that are unrelated to a specific stock.

H. I’ll sell when I believe there is a market crash or a significant correction pending and I want to preserve my capital for reinvestment at substantially lower prices.

This happened in 2008. Although I was slow to recognize the crash, I did manage to sell everything I wanted to sell about 30% into the downward leg. I started buying again near the bottom and continued buying until the Dow approached 11,000. This enabled me in 2009 and 2010 to more than make up for my 2008 losses.

I believe we are on the verge of repeating the crash. Consequently, over the past weeks I’ve sold most of my equity positions so I’ll be prepared to start buying again when the market is 20% to 30% lower.

I don’t know how to time the market better than anyone else. But I’m convinced that the current economic “recovery” is phony and more importantly – it’s over. I’ve no idea where the bottom will be. That’s why I’ll start buying when the market is 20% to 30% down and I’ll continue buying a little at a time while events play out.

I hope to “dollar cost average” the market bottom and “bracket it” in field artillery terms.

I. I’ll sell my weakest investments when I need cash to invest in a much better opportunity.

When I identify a strong new investment opportunity and I have insufficient cash available to purchase it, I’ll chose one or more of my least attractive current positions to sell. Using the proceeds of the sale, I’ll buy the new stock.

In practice, I’m never fully invested. I maintain a cash reserve in case an extraordinary opportunity presents itself. However, if my reserve is at my minimum target value, I’ll still sell my weakest investments to raise additional cash for the new stock.

Since the recent rally peaked, I’ve steadily increased my cash reserve in preparation for the expected downturn. As my target cash reserve figure increased, there have been multiple occasions when I sold weaker investments to purchase stronger ones.

J. I’ll sell my weakest investments if an emergency situation requires more cash than I have available.

If a family disaster occurs selling investments could become necessary. However, my wife & I maintain emergency accounts as well as insurance that we hope will prevent this situation.

Retirement Income

Most people would include generating income in retirement as a reason to sell stocks; not me. I buy only dividend stocks and I plan to use only the dividends as retirement income. I’ll let the stocks appreciate over time and continue increasing their annual dividend payouts.

Summary of the Reasons I Will Sell Stocks

A. The company stops paying a dividend.

B. The stock’s price increases such that the dividend yield falls below 2% and the P/E ratio rises above 25.

C. The company’s earnings decline enough that the dividend payout ratio exceeds 100%.

D. The stock’s “Financial Score” is a negative number.

E. The company’s survival is threatened by a very large legal liability.

F. The company enters into a major merger agreement.

G. The stock’s total return falls below 10%.

H. I’ll sell when I believe there is a market crash or a significant correction pending and I want to preserve my capital for reinvestment at substantially lower prices.

I. I’ll sell my weakest investments when I need cash to invest in a much better opportunity.

J. I’ll sell my weakest investments if an emergency situation requires more cash than I have available.

I hope you find this series of posts on “When to Sell” interesting. Writing it has clarified my thinking about selling stock. For me, it was a profitable exercise.

Link to Topics in the Special Report: "When to Sell"

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