Peter Lynch’s One Up on Wall Street — When to Sell a Stock
Hello! Welcome to Part 3 on the “One up on Wall Street” Series. This will be the final part, and it is about Peter Lynch’s advice on when to sell a particular stock.
You can get the book from Amazon here: https://www.amazon.com/One-Up-Wall-Street-Already/dp/0743200403
You can see Part 1 here:
Peter Lynch’s One Up on Wall Street — The Six Categories of Stocks
As someone who wants to learn about investing (and has a lot of free time), I’ve spent my time reading through…
You can see Part 2 here:
Peter Lynch’s One Up on Wall Street — The Stock Buying Checklist
This is part two of my series on Peter Lynch’s One up on Wall Street. Part one can be found here:
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With no further ado, let’s get into the content of the article. It is important to read Part 1 at the bare minimum to understand this. It’s better to read both Part 1 and 2 before reading Part 3.
When does one Sell?
We have covered the basics on when to buy a particular stock and what to look out for. Obviously, there is much more than that, and it is better to seek out other resources like Aswath Damodaran’s lectures or Benjamin Graham’s books. However, in the scope of One Up on Wall Street, we have covered what Peter Lynch has let us know about. Now, we will look at when to sell a particular stock.
This is something that people always struggle at, as they can sell stocks too early, or too late. It is important to remember that it is very rare that one sells a stock at the perfect time. Therefore, it is alright to sell a bit too early or too late. There are, however, good identifiers of when to sell a stock, which varies on the six types of stocks.
When to Sell a Slow-Grower
- The company has lost market share to competitors over two/three consecutive years
- No new products are being developed and there is little spending on R&D. This happens when companies decide to rest on what they’ve previously sold.
- The company is acquiring entirely unrelated businesses in an attempt to diversify, or as Lynch calls it, ‘diworseify’.
- The company’s balance sheet has taken a turn from strong to weak, either by a decrease in cash position or an increase in debt, or both.
- The dividend yield has dropped in consecutive years. This makes companies that are solely bought for their dividends less and less attractive.
When to Sell a Stalwart
According to Lynch, it is better to replace these stocks with stocks of similar quality (i.e. another stalwart) of another company.
- There has been no insider purchases of the company’s shares for the past year.
- A major division that contributes 25% or more of the company’s earnings is exposed to an economic slump (like a housing crisis).
- New products in the market have been average, bad or horrible, and there are new developments planned further in time.
- The stock has a higher P/E than those in its industry.
- The company has a consistently slowing down growth rate, and is maintaining profits by cutting costs, which is limited.
When to Sell a Cyclical
From the outset, it looks obvious when to sell a cyclical: At the end of the peak of the cycle, of course! However, it is difficult to predict when the company’s cycle is over. Since the stock market is sometimes funny in the way it behaves, stocks can go down for no apparent reason, even if they seem to be doing well.
- The best time to sell is when something begins to go wrong. This includes rising costs of production, plants are at full production and nothing more is able to be made or when companies need to spend more to produce more.
- Another sell signal is when the company’s inventory builds up and it is unable to sell their products. This means decreasing profits and lower profits down the road.
- Falling commodity prices is another time to sell. When the prices of commodities like oil or steel continue to fall, the earnings could be impacted depending on the industry of the cyclical.
- The company cannot compete with competitor companies, whether they be foreign or local.
- And obviously, last but not least: Decreasing demand in the product.
When to Sell a Turnaround
The best time to sell a turnaround might be fairly obvious: At the end of the turnaround. This is when the company’s problems are over, and that the company has either become its old self, or it has become one of the other five types of stock. This is when the turnaround is successful. If you want to solely trade in turnarounds, then this would be the time to sell. However, there are some signs to sell a turnaround:
- When the level of debt increases at a rate higher than assets and cash of the company
- The P/E ratio is inflated relative to earnings prospects.
- The inventories are rising at a higher rate than the rate of growth of sales.
When to Sell an Asset Play
These kind of stocks are one that I am not entirely familiar with. However, according to Lynch, these stocks are better sold when raiders find assets and purchase them, usually at an inflated price. This allows the company’s stock to increase. Therefore, the best time to sell an asset play might be when companies sell their assets at a price lower than expected.
When to Sell a Fast Grower
The best time to sell a fast grower is when there is little or no room for growth. Lynch cites Holiday Inn as an example. After it exploded 40 times over, and was found in almost every corner of the world, it was known that it wasn’t possible for the company to grow at a sustainable rate. Then, Lynch sold Holiday Inn.
The trick with selling fast growers is that you don’t want to miss an additional spurt in growth of the stock, but you don’t want to sell after the stock has dipped as well. Here are some tips that Lynch suggests:
- Lower growth rate over consecutive years with not much future scope of expansion.
- New store or product results are disappointing
- The stock is selling at an inflated P/E which is higher than projected growth.
- Sales and Profits are decreasing over consecutive years
Some Final Notes
This will be the end of the Peter Lynch series. We looked at when to sell a particular stock depending on the type of stock. Sadly, I was not able to provide much in terms of information on Asset Plays.
Nonetheless, I will write about Aswath Damodaran’s principles of finance series, and my understandings from that series. Thank you!