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When Do You Sell the Winners?

June 20, 2017, 12:57 pm

I was recently asked about how I decide when it’s time to lock in profits. And that’s a really excellent question. The decision to sell a stock is just as critical as the decision to buy, which is why my method of selling winners is a mix of art and science versus a generic formula.

My first step is to establish a sell target. These are usually an estimate of where I think a stock can trade within the next six-12 months based on my estimate of forward earnings and a reasonable multiple based on the company’s long-term growth, general market conditions and how industry competitors are valued.

When a stock hits my target, I then determine whether it’s best to sell, hold or raise the target. If I feel the stock can continue to outperform over the short to intermediate term, I will generally raise the target. For example, if I have been holding a name for a year and its earnings have been strong and the trend is likely to continue, I am comfortable raising the target as the market begins to discount next year’s higher earnings.

On the other hand, if the stock reaches or comes close to my target in a short period of time, this is a sign that it may be getting ahead of itself and could be vulnerable to a pullback. This was the case with GameChangers winner Cantel Medical (CMD, +15%) a few weeks ago, which ran up quickly on no news. While I believed the Street’s negative reaction to CMD’s fiscal second-quarter earnings in March was overdone, the stock recovered faster than I expected and momentum looked vulnerable heading into its fiscal third-quarter report on June 8. With the shares fully valued, it was best to stay disciplined and lock in our quick gains.

There are always exceptions to the rule, and in that case it is The Trade Desk (TTD, +35%), one of my GameChangers picks that went on an outstanding run. I have raised my price target on the name three times now, driven by three factors. First, there was the strength in its first-quarter earnings, which easily exceeded results on the top and bottom lines. This drove higher forward earnings estimates. Second, there was strong momentum in the shares as the earnings report was well received. And third, while the stock carried a premium PE of 40X next year’s EPS estimates, an even higher valuation seemed possible given the stretched valuations of several growth stocks, especially those in the software industry that are supported by the low interest rate environment.

Put simply, my decision on when to sell a stock rests largely on whether future outperformance can continue. I think about the strength of any earnings releases since I initially recommended the name, its longer-term outlook, its valuation compared to other companies in the industry and the momentum the stock has at the time.

2 comments

  1. Nice to watch your thinking process, based on your experience. For me it may be simply that I need more capital for some good new comers, so I’ll sell maybe half of a good winner

    Comment by Tom on June 20, 2017 at 5:43 pm
  2. I believe this response may have been directed to a question I posed of you. However, to carry this one step more, and I believe the response may be somewhat different, would you say the same for selling options (which I believe I may have included in my first question).

    Comment by Harold Wohl on June 21, 2017 at 8:20 am

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