It's the age-old dilemma. When to sell?

AVNER MANDELMAN
At least once a year I ask money manager friends what rules they use for selling. Often I get a verbal squirm, because although buying well is not easy, at least the criteria are clear, and many investment books detail them: growth, value, yield, neglect, you name it-- even sleuthed physical information now has a book. However, when do you sell?
Warren Buffett said that if you buy well, you never sell. This may work for a genius investor, but for the rest of us some pointers are necessary. Below, then, are six reasons for selling, according to my canvassed friends, plus my commentary.
First and foremost, you sell when management didn't deliver on a major promise, or lied. This one I fully agree with. They promised to develop the fastest widget but instead are making slow widgets in volume. Or they said they'd hire only the best, then promoted the chief executive's cousin who is definitely not Mensa material. They said they'd write off a division, but instead are expanding it. In all these, sell.
The second rule is by fund managers who say you should sell on any disappointment, because, like roaches, when you see one, usually more are coming. For me, however, this is a bit too twitchy.
Not even the best management is perfect, and sometimes minor disappointments should be seen as a chance to add to positions if the long term is still good. I said "if." But how do you know?
My test is -- check with the company's customers. Take them to lunch or drinks and ask. If they are calm, you should be too. If they are twitchy, make ready to sell. What if you don't know any well enough to take them for lunch? Then maybe you shouldn't be in the stock to begin with.
The third rule for selling is a deteriorating balance sheet. Debt, as U.S. newsletter writer Jim Grant once said, is always repaid, either by the borrower or by the lender. So if a company takes on too much debt, most fund managers usually sell, so do I, and so should you.
What of high price? That's the fourth rule, which has two parts. The first is mushier and harder: You should sell when the price has gone way beyond any reasonable valuation, then never look back. And just to make sure you understand how hard this is, here is an example.
Years ago Giraffe bought Novatel GPS at very low single digits, because the company had the best GPS technology and the stock was ridiculously cheap. Then, Oncap took a position by buying NGPS's parent (BAE), and in three years the stock soared to $15 (U.S.). It then traded at such high multiples of fundamentals, that although the company was better than when we had bought it, we had to sell.
The stock flew on to $50 -- at which point Oncap sold too. I couldn't sleep for two weeks. The stock plunged to $15. I slept much better. Bad move. I should've woken up and bought again. Now the stock is at $38 and may one day see $100 -- but it's no longer dead-cheap, so we look for other neglected gems.
Would I have done it differently? Not really. Am I happy about this? Not really; my pride is hurt. But value sellers rub their hurt pride with profit. It helps. You should sell when your value buy soars beyond expensive, then use your profits similarly.
Which brings me to the easier part of the fourth rule: Sell when crazy day traders discover your stock and want to buy it, no matter the price. That's one Giraffe has become sort of an expert on. Because we look for neglected cheap gems, these can languish for a year or two, but then be discovered by Internet day traders, when there can be a melt-up on large volume. To catch such moments our spreadsheets are programmed to "Ping!!" when traded volume reaches a high percentage of a stock's total float.
When a stock of ours soars on such high volume, we sell. We figure that if day traders think they know much more about a stock of ours, social justice dictates that we give it to them. (We often buy the stock back cheaper a few weeks later.)
Even if you don't have a real-time spreadsheet, you should be alert for such a possibility, too. If your stock rises on such huge volume that you feel euphoric -- consider selling. Euphoria should be a trigger for selling just as panic should alert you to a possible buy opportunity.
The fifth rule is more one for money managers than for individual investors, but I mention it nevertheless -- a stock that has risen so much that it is now a too-high portion of the portfolio. As an individual, you can keep a higher portion of your registered retirement savings plan in one stock (though it's not advisable), because you act as a principal.
But when Giraffe, for example, acts as an agent for others, we cannot allow more than a certain percentage of the portfolio in any one stock, because this makes the portfolio too volatile. It's like driving a car -- when you drive alone, you can go faster since you are at the wheel; but when you have passengers, although they know in their heads you're a good driver, their gut is twitchier, so you better go a bit more slowly. You'll get there anyway; no need to make your passengers lose their lunch.
The sixth and last reason for selling is the simplest: Sell when and if you find you have made a mistake. In such a case, don't delay. Admit it, cut your losses, and drive on. Errors in buying are hard enough; no need to complicate them with errors in selling. What matters is the final profit you get to rub on your occasional wounded pride.
Avner Mandelman is president and chief investment officer of Giraffe Capital Corp. and the author of The Sleuth Investor amandelman@giraffecapital.com