The Worst Reasons To Sell A Stock

An article on when to sell a stock would not be complete without some discussion about what I consider to be the worst reason to sell a stock. Ironically, this reason may be the one that is most commonly implemented by investors. Personally, I will rarely, if ever, sell a stock just because the price has fallen. If I’ve done my initial homework correctly, then a falling stock price would represent a great buying opportunity, not a rational reason to sell. If I buy a stock at $20 per share that I believe is worth at least $20 per share or more, then it seems logical to me that I should love it at $15 or even $10 per share. Of course, this is only true if the fundamentals remain solidly intact.

I believe that if fundamentals remain strong, a price drop is more likely to initiate a buy decision than it is a sell decision. I believe this is important because in my anecdotal experience most investors are inclined to sell a stock if the price drops below the price they paid. Admittedly, averaging down doesn’t always work out as expected. However, I have seen more people take unnecessary losses by selling a perfectly good stock than I have seen people losing more from averaging down into a sound and growing business.

Avoid Selling Just Because the Price Drops: Cognizant Technology Solutions a Textbook Example

In June 2007, prior to the Great Recession, I initiated a position in the growth stock Cognizant Technology Solutions (CTSH) for my total return portfolios. Note by the green dot on the graph that I purchased the company at a P/E ratio of 42, which indicated fair value based on its earnings growth rate of 43.5% (P/E ratio equal to earnings growth rate). From that point forward, the stock went on a freefall and by January 2009 right in the throes of the Great Recession, the price of this great growth stock was nearly cut in half from $19.85 when it was first purchased to $10.19.

However, as I stated in the introduction since I loved the stock at $20, I was crazy about it at $10.Therefore, considering that earnings continued to grow at a very high rate over this timeframe, instead of panicking, I enthusiastically doubled down on the stock. Note by doing so, I lowered my cost basis from $19.85 to $15.02.Although my timing actually turned out to be almost perfect, it was actually a combination of luck and good analysis.

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Disclosure: Long CTSH.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks ...

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Caitlin Snow 3 weeks ago Member's comment

Maybe some emotion is a good thing when you learn what a lousy company CTSH is. Here's another report on a really crummy and badly handled part of their business, which was on newspaper front pages today: www.tampabay.com/.../these-tampa-workers-see-disturbing-facebook-posts-so-you-dont-but-it-takes-a-toll/