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.