Knowing when to sell a stock is one of the hardest parts of investing, in my opinion.
Luckily, many of the best investors of all time have shared their advice on this topic.
Let’s review some advice from my favorite investors of all time, Joel Greenblatt.
He wrote my favorite investing book, You Can Be a Stock Market Genius, which described the opportunity for individual investors to make serious money investing in stock spin-offs and other special situations.
Greenblatt ran Gotham Capital for a year and generated ~50% annual returns for a decade.
Greenblatt focused on “special situations” and so his approach will be different than growth investors.
But in general, Greenblatt gets involved with an investment because he’s identified an opportunity that should provide a good return over a specified time frame.
When to Sell a Stock According to Greenblatt
“Whether you own a spinoff, a merger security, or a stock fresh out of bankruptcy there was a special event that created the buying opportunity. Hopefully, at some point after the event has transpired, the market will recognize the value that was unmasked by the extraordinary change.
Once the market has reacted and/or the attributes that originally attracted you to the situation become well known, your edge may be substantially lessened. This process can take from a few weeks to a few years. The trigger to sell may be a substantial increase in the stock price or a change in the company’s fundamentals (i.e., the company is doing worse than you thought).
How long should you wait before selling? There’s no easy answer to that one either. However, here’s a tip that has worked well for me: Trade the bad ones, invest in the good ones.
What ‘trade the bad, invest in the good’ means is, when you make a bargain purchase, determine what kind of company you’re buying. If the company is an average company in a difficult industry and you bought it because a special corporate event created a bargain opportunity, be prepared to sell it once the stock’s attributes become more widely known.
In Charter Medical’s case, even though the company’s earnings continued strong after I bought it, I still kept in mind the difficulty and uncertainty surrounding its main business. The stock price started to reflect positive reports from Wall Street analysts and the popular press, so I sold it. No science. The stock still looked relatively cheap, but Charter was not in a business I felt comfortable investing in over the long term….
On the other hand, a company whose prospects and market niche I viewed more favorably, American Express, turned into a long-term investment.”
The “trade the bad ones invest in the good ones” is helpful for me because many of the investments that I make are spin-offs.
With spin-offs, usually there is some “hair” whether it’s high debt, poor business quality, or corporate governance concerns.
As such, once the market starts to recognize the spin-off’s value, it’s usually a good idea to trade out.
For example, I recommended BBX Capital (BBXIA) to Cabot Micro-Cap Insider members in October of 2020.
At the time, the company was trading at a 60% discount to the value of net cash on its balance sheet.
Often times, companies with large net cash balances are burning cash like crazy (think unprofitable biotechs).
But in this example, that wasn’t the case.
BBX Capital had valuable operating subsidiaries that were generating positive free cash flow.
So it was a “no brainer” buy.
Sure I had some concern about corporate governance (management controlled the company through class B shares and paid themselves rather generously).
But at that valuation, I could hold my nose and buy.
It was an easy decision.
Over time, the market started to give BBX Capital a little more credit.
And by May of 2022, I was happy to recommend Cabot Micro-Cap Insider members trade out at a profit of 133%.
Sure the stock still looked cheap (it was still trading at just 50% of book value!), but it was no longer a “no brainer.”
Knowing when to sell a stock is one of the most investing difficult decisions you will face.
But remembering Greenblatt’s advise to “trade the bad ones, invest in the good ones” should make it a little easier.
What rules do you apply when determining when to sell a stock?