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Bottom of the Barrel: The Art of the Sale

While I was traveling last week, I received an email that made me think long and hard about one of the more difficult tasks for an investor: selling. Because this reader's email asked about a couple of Bottom of the Barrel stocks, I figured it was time to think about the process of deciding when to sell your small-caps.

Compared with deciding when to buy, knowing when to sell is a chore. Hundreds of theories exist about when to sell, and all of them are right and wrong, depending on your investing philosophy and risk tolerance.

Ironically, selling discipline is always more difficult than buying discipline, largely because selling is always remembered. Just think about the sales you've second-guessed and compare them with the bad buys you remember. The sales stick out more vividly, at least more often than the reasons why you bought the stocks in the first place.

Fundamentally Driven

Most of my selling discipline is fundamentally driven. I've written about what I look for when selecting a small-cap company. In a simplistic way, one reason to sell is if one of those tenets is violated. Here's a quick checklist of things to look for that might cause me to sell:

  • Change in management: This is always a red flag for me. If I've owned a company that has a sudden management change, I usually exit without asking many questions. Confidence in management attracts me to a small-cap company. When that changes, it's hard to assess the future immediately. Therefore, unless the management succession is clearly articulated, orderly and expected, I almost always reduce my exposure. In the small-cap world, limiting uncertainty limits losses.

  • Change in business focus: Many times, small-caps are like adolescents: They don't know what they want to be when they grow up. As those who follow my Bottom of the Barrel series know, I focus acutely on a company's business lines. So if there's a change in the business focus, even a subtle one, I take a hard look at the reason for it. That doesn't always induce me to sell, but it often signals that the current business plan isn't working. Again, I want to know what I own, and a surprising change usually compromises my position.
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