Thoughts on Selling to Lock In Gains

[Dan Mac @DGSInvesting]

I read an article on Seeking Alpha yesterday (found here) where the author talks about selling dividend growth stocks that have large gains shortly after you buy them. For example, if I bought MCD and within the next half year the stock price goes up 20 or 30% the author argues you should sell and lock in those gains. Then you can purchase later when/if the price comes back down to a lower valuation.

I've always been in the camp of buy and hold forever (unless something changes with the company). What are your thoughts? Do you ever consider selling when you get some quick large gains?

[fiveoh]

I would consider skimming a position that has run up quickly, only if I had a good alternative investment to put it in at the time. Preferably this would increase my overall div yield as well. I haven't done this yet, since I usually have new cash to invest instead.

[hendi_alex]

I always have target weightings in mind. Just the act of re-balancing would capture some of those gains so that they can be deployed into something that appears to have greater current value. On the other hand, the market can be quite irrational in the way it values a company's share price. Why not harvest those gifts when there is a serious disconnect between the value of the shares and what you feel that the company is actually worth. If the disconnect is real, then the share price will always drift back down to a more reasonable valuation to provide a fresh entry. Given that we can never make a 100% accurate assessment on such things, it makes sense to me to always keep some portion, that which is considered the core holding. That way if the market is correct, and the shares just keep going up, never to look back at the previous price level, the portfolio is still along for the ride with those retained shares.

[Kerim]

This is another great topic.

I'm usually of the mind that I'm going to buy and hold these stocks for decades. And my plan is to buy when I think valuations are good, so there is a margin of safety. But while it is hard to time a buy decision, I think the sell decision is even harder.

There is a good argument to sell when your shares have become overvalued. This is not the same as saying that your stock has had a strong run up in price, however, and the distinction is important. If I buy AFL in the $40s, believing it to be significantly undervalued, and I think it is fairly valued, or still slightly undervalued, in the $60s, then it would be silly for me to sell in the $60s just because of the strong run. Now if it gets to the $80s and I think that is noticeably over-valued, that is when there is a tough choice to be made for a dividend growth investor.

Graham and Buffet and their ilk have been wildly successful buying when undervalued and selling when overvalued. And it couldn't seem any simpler than that. And while I am reasonably confident that I can spot undervaluation, I am not as confident with overvaluation. While they would seem to be two sides to the same coin, I think there is a big difference. When you make a buy decision, and you are dealing with a quality dividend growth stock, time is on your side. Even if you were a bit wrong about the valuation, you should do just fine over the many years ahead that the company has to grow its earnings and dividends, with the share price in tow. It is not the same with a sell decision -- if you're wrong and the stock is not overvalued, you miss out on the future growth of the company. Moreover, if you believe in staying mostly invested, you need a better place to put the cash than the company that you sold. In a down market where there are opportunities aplenty, this might be no problem at all. But when prices are up generally, it is harder.

On balance, then, although I see the logic in it, I personally have not yet been interested in selling off any of my winners. I've only sold where I see problems with the company or my original thesis in buying the stock has proven incorrect. My plan on buying is to hold for decades and enjoy the growing income stream, and I'll take a run-up in price as validation of the buy decision, but not as an invitation to part ways with the stock.

On the other hand, if I had no dry powder, had something that felt overvalued to me, and there was a screaming opportunity that I was dying to jump on, I could see making the move. Or I could see selling off a portion of my portfolio generally if we found ourselves in another dot-com-type mania.

[cannew]

(11-07-2013, 10:06 AM)Dan Mac @DGSInvesting Wrote: I've always been in the camp of buy and hold forever (unless something changes with the company). Do you ever consider selling when you get some quick large gains?

Would only consider selling if the company has cut it's dividend, stopped increasing the dividend (and my YOC is low), there is no sign the company will begin increasing anytime soon, or I feel the company is running into deep trouble.

I would never sell just to get a quick gain unless I needed the money.

I hold stocks for the growing income. Chances are if a company is expensive, they are showing good earnings and increasing the dividend. I definitely would not be adding to the position.

[Dan Mac @DGSInvesting]

I agree Cannew, those would be the reasons I would consider selling as well.

I would also consider selling if valuations reached exceedingly ridiculous levels (see 1999 to 2001 just before the dot com crash). I think if my Coke stock (or any of the types of companies I typically buy) began trading at P/E's above 40, I would have to think hard about locking in gains knowing that we would be just a year or so out from a big market correction where I could then buy back into my positions at more reasonable prices.

[KenBob]

I now extremely rarely sell a stock due to a large price rise. However, if the stock is overvalued, it does make sense to sell the stock for another which is more reasonably priced.

The problem is that a stock will get ahead of itself, meaning it is priced at future value instead of current value. Selling a stock in this case then has the potential of a future repurchase with the loss due to taxes from the previous sell.

I only sell a stock which is overvalued compared to future value. My future value is based on 5 years of dividend growth. I use 5 years since a longer extrapolation would be unreasonable.

[cannew]

Most of the good DG stocks have a built in corrector. Other than the true DG investor, people buy them when the yield is attractive (or they are following the advice of advisors), but when the price goes up, the yield drops and other investors are less interested, and the price drops closer to where is should be.

[Kerim]

(11-07-2013, 07:32 PM)KenBob Wrote: I only sell a stock which is overvalued compared to future value. My future value is based on 5 years of dividend growth. I use 5 years since a longer extrapolation would be unreasonable.

That makes a ton of sense to me. "Mere" overvaluation, as measured by a somewhat higher than usual P/E should not be enough to trigger a sell on a carefully chosen dividend growth stock. But when the price gets really out of line, as measured against future expectations, then it might be a good time to take the gain and deploy the capital elsewhere.

(11-07-2013, 07:48 PM)cannew Wrote: Most of the good DG stocks have a built in corrector.

This is a very good, and often unappreciated, point about DG stocks. As earnings and the dividend grow over time, they drag the share price higher along with them.

[EricL]

Another great article by Chuck Carnevale on Seeking Alpha along the lines of the question posed on this thread.

How Do I Know When To Sell A Stock?

[rnsmth]

I have bought more of a stock after a price run-up - PG, JNJ are but two recent examples - and they have kept going up - and I think they will keep going up.

[Dividend Watcher]

I've already proven many times over I'm a lousy market timer. My latest was EMR. My cash secured put was filled with an effective cost in the low 40s. When it went up to the low 50s and the P/E was high teens, I sold a covered call thinking I'd just harvest the premium never thinking that, after a brief rest and an optimistic (at the time) earnings report, that it would charge higher. It was called away a few weeks before the expiration date in what I'm guessing was a dividend play.

I now usually only trim something that is an exceedingly large holding and only if I see something better valued that helps diversify the portfolio or the revenue stream. I did swap out BDX for BAX on the recent dip with BAX in my wife's portfolio only to capture a higher dividend stream. Using my estimates (guesses, really), it would take 15 years for BDX's higher dividend growth rate to exceed the income from BAX. A lot can happen in 15 years so I have time to watch and evaluate.

If valuations do get crazy, such as the late 90s, I think I'll reduce a lot of the holdings to build some capital. Hopefully I'll recognize it before it's too late.