4/26/08

When Should You Sell a Losing Stock?

I'm no expert or financial genius, but in considering whether to sell or keep the shares, I'd think about the following things:

1. Do you have solid reasons to think the company will turn around? E.g., is there new/better management in place now? Is there a new plan being implemented that you think will increase profits, etc? If the company is in a declining industry, what reasons are there for an industry turnaround?

2. What were your reasons for investing in the first place? If they were good reasons (gut feelings or someone else's recommendation don't count), are they still valid now?

3. Why would anyone else (a competitor, regular investors) buy the company now? Reasons for buying an unprofitable company could be that its assets (cash, equipment, building, etc) minus liabilities are worth a good deal more than its market capitalization. This is very rare.

4. What's going on with the loser's competitors? Are they experiencing similar problems (i.e., is it an industry wide problem?), or are their prospects much better (i.e., the loser just has terrible management/business plan/products)? If the latter is the case, I'd sell the loser and buy one of the competitors. You'll still be exposed to the same industry, but now you might have a deductible capital loss.

If your only reason for keeping the loser is the (gambler's) hope that the company's prospects will magically improve or it'll be bought out, you should sell the stock. It'll be the right decision even if for some strange reason it does get bought out or does improve. As long as you buy/sell stocks for rational reasons, I think you'll do fine in the long run.

Taking Lauren's comment (to my sold Dupont post) as an example, suppose your stock lost around 77% of its value, turning your $350 investment into $80. If your only reason for holding on is hope for a buyout or improvement, you should sell. For example, let's say it gets bought out. What would the premium be over the current market price? Let's say it's 100%, which I think most people would agree is far fetched. That would turn the value of your investment into $160. That's certainly better than $80, but you're still losing almost half your principal. Is it worth the risk to keep holding the stock because of the hope that your loses will be less, especially if the stock is being delisted? That $80 would probably be better invested somewhere else.