All investors share a goal. Making profit. How do you know when to cash in on your winners? A stock is up 20%-50%-75%. Will it keep going up? Is it about to crash? You feel you should sell, but you like that stock… Selling winners isn’t easy.
Some put a limit on the stock price gain, for example, when they’re up 50% they sell the position. As a dividend growth investor, I choose stocks I want to keep for a long time, not for a quick buck. When you hold on to solid holdings for a long time, you can get to triple-digit growth—much more interesting than 50% isn’t it? Patience can generate a lot more return than selling triggered by a cap on value appreciation.
That said, there are appropriate moments to cash in on your winners. Below, I’ll explain what I do to decide whether to sell, or trim, my winners.
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Why sell?
I have two main reasons to sell a winning position or trim it of a few shares. The first is when my motives for buying the stock aren’t valid anymore. In other words, things have changed for the company and my thesis for investing in it in the first place is no longer true.
The other reason relates to portfolio management. When a position becomes too large, i.e., it’s overweight, my portfolio isn’t perfectly balanced, and my exposure to risk increases. Let’s look at these in detail.
Stock no longer fits my investment thesis
Every quarter, I review all holdings in my portfolio to see how they’re evolving with their most recent quarterly results. For each stock, I verify whether my investment thesis is still valid.
The investment thesis is the narrative, the story that explains why I bought the stock in the first place. It explains what I found compelling about the company and why I’d want to hold its stock forever (or 10 or 20 years).
For example, what made me confident and liked about Alimentation Couche-Tard (ATD.TO) is that: it was constantly growing by acquiring other convenience stores around the world, and also innovated to grow organically, for example, by selling fresh produce, coming up with new promotions, digital transactions, loyalty programs, etc.
During my review, I’ll see if this story changes. If ATD stops acquiring other companies or runs out of ideas for organic growth, I’ll flag it and I might eventually sell.
Backing it up with the numbers
During my review, I look beyond the narrative. Numbers. I review the dividend triangle to see the company’s trends for revenue, earnings, and dividend growth.
When the investment thesis no longer applies, looking at the triangle can confirm my suspicion that the stock isn’t as appealing as it once was. If I see revenue and earnings growth slowing down, dividend growth will likely slow down too, eventually. The company is not the company I bought originally.
I’m not trigger-happy. I don’t sell immediately following one poor quarter. However, if it’s one bad quarter after another, and my thesis isn’t right anymore, it’s time to sell and cash in my profit. Sticking to a quarterly review gives me great odds of being able to spot the issues and sell while the stock price is still high, making a nice profit.
Overweight sectors or positions
Should you cash in on your winners that still match my investment thesis and show good growth trends, as is the case with ATD.TO?
I like to let such winners run, but I might trim them if it’s needed. You see, my quarterly ritual includes reviewing my portfolio sector allocation and stock weight.
Am I overweight in a sector? If so, I could suffer a lot if a crisis happens in this sector. Remember tech stocks in 2000? I will trim winning positions in an overweight sector to rebalance the portfolio.
Overweight positions
How can you tell you’re overweight on a single holding? That depends on two factors: how many stocks you want in your portfolio, and how much you are willing to lose on a single bad investment.
If you want 40 stocks, having equal-weighted positions means each stock should occupy 2.5% of your portfolio (100/40). If it’s 30 stocks, then each one would occupy 3.33% of your portfolio. You might let your favorite stocks exceed that maximum weight at 4% or more, with others occupying less than 3.33%.
As stock prices fluctuate, your stocks’ weight changes. Some winners can exceed the maximum weight by a lot. You can trim such positions right away by selling enough shares to get their weight back to where you want it.
But I love this overweight stock…
We get attached to our winners; I know. If your investment thesis for the company is still valid and the numbers back up your feelings, ask yourself how much you’re willing to lose on a single bad investment. Is it $5K, $10K, or $20K? You come up with this arbitrary amount based on your situation and risk tolerance. Let’s say it’s $20K and your portfolio is worth $800K; you’d be okay with losing (20/800*100) = 2.5% of your portfolio on a single bad investment
The worst that happens on the market is a ~50% crash of its value. We saw this when the tech bubble burst in 2000 and during the 2008 financial crisis. With that in mind, look at your overweight position: if it drops 50% in value tomorrow, is that loss lower or higher than 2.5% of your portfolio? If it’s more, time for a diet! Trim that position, even if you love the stock.
Knowing that the worst market loss is ~50%, and you’re okay losing 2.5% of your portfolio value, your maximum weight per stock is 5%. Trim any position that exceeds 5% to rebalance your portfolio and reduce risk.
Overweight winners are usually stocks that have performed well and gained value. Trimming them by selling a few shares lets you cash in on your winners while staying invested in the company to benefit from its future growth.
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In retirement
If you are retired, you might have to cash in on your winners by selling a few shares to supplement your income. Perhaps your dividend income isn’t enough, inflation outpaced dividend growth in your portfolio, a holding cut its dividend, or extra expenses came up. Whatever the reason, these guidelines can help you choose which stocks to sell, how much to sell, and feel good about it.
Your approach to selling makes sense. I need the courage. I have so many winners. When I back tested these stocks to the current scenario, I would have lost a lot of upside. It is not one or two – but I have a few in that situation. I hold US stocks as well and Canadian – and this particular scenario is true in these US stocks. If I sell these winners early, I feel bad when they perform so well. Yes. *Very Very* bad. It has happened to me: NVDA is a fine example. I sold some positions early when it spiked up by 110% Now, I could have made more money if only I held it at those prices. I still have some NVDA and some securities that is showing good profits. They are nudging close to 100% (Doubling with DRIPs). I am not so sure if I cut back on these. And then, what do I do with these profits..? Of course, cap gains tax come into play and then do I put more of that in some of the losers which showed promise some months ago?
Take Canadian: The banks were performing well. I am still in the positive cash flow. I read your blog about Canadian Banks. You are right on. Some of your analysis of certain banks (BNS) explains why it has been moving sideways. Thanks for these articles. I always read yours with interest.