Owning a stock -- especially if it has gained in value -- presents an investor with some tough choices. You can't lose money when selling a winner, but you might time the trade wrong and miss an even better run-up in the future. On the other hand, by simply buying and holding the investment, you might be missing better options. There are several other factors to consider before pressing the sell button.
The basic measure of any stock's value is the price-to-earnings ratio. A stock selling for $100 for a company making $10 a share has a P/E of 10. Investors must consider the average P/E of other companies in the same business sector, and the historical P/E of the company itself. If the P/E runs up after good news or a market advance, shares may be getting overvalued -- meaning it's time to sell. If the P/E falls, then shares are getting relatively cheap; a shareholder then needs to consider the reasons for the drop before selling, holding or adding more shares to his position.
An important "fundamental" factor in investment decisions is a company's future prospects. There are many pieces to the puzzle: the value of the company's products and services; the state of the competition; the general health of the economy and the company's own business sector; and the possibility of mergers, spinoffs and acquisitions. To keep informed, investors need to keep tabs on company news in the media, read press releases, study research reports and seek out advice from people that know the company and the market.
When a company pays dividends, it rewards shareholders with a slice of its net income. The payment of a dividend tends to support the price of a stock. When a company raises or initiates a dividend, it sends a signal that business, in general, has been good. Cutting or eliminating the dividend means the company needs to preserve cash more than it needs to keep the stock price up. Even if you believe in the company's prospects, this kind of action will tend to depress the value of your holdings. Stockholders also should consider the dividend return on stocks versus interest paid on fixed-income securities, which are less volatile and risky.
Market Returns and Risk
Another important factor is your own outlook on the market and your tolerance for risk. Investors who feel the market in general is overvalued (as measured by P/E) consider selling shares and moving into fixed-income securities, money markets or cash. If retirement looms or an investor has some "big-ticket" purchases such as college tuition on the horizon, it's smart to move away from high risks (such as small-company or tech stocks) and into safer investments, such as steady dividend-payers or utility companies. Above all, it's best to keep a cold, analytical eye on the markets -- and on the business -- and not hold on to shares out of nostalgia, inertia or blind hope.
Founder/president of the innovative reference publisher The Archive LLC, Tom Streissguth has been a self-employed business owner, independent bookseller and freelance author in the school/library market. Holding a bachelor's degree from Yale, Streissguth has published more than 100 works of history, biography, current affairs and geography for young readers.