Monday, May 07, 2007

Exit strategies

Dubya could use one in Iraq right about now. And if you've ever put a buy order on a stock in your life, you'd be well served to give some thought to one yourself.

I'm talking about exit stategies. If you're anything like me, most of your investing thought process is dedicated to the buy side. Should I buy this stock? Why? At what price? If you've done your homework, chances are you won't end up buying far more stocks than you have an initial interest in -- because let's face it, there's no such thing as a good stock to buy at any price.

It strikes me that making money in the stock market is 50% due to buying the right stock at the right time. But what about the other side? Unless you sell it at the right price, all your hard work on the front end is wasted.

It's for that reason that for every stock I buy, I like to have a general guideline of at what point I'd consider selling the stake. I mean, if I buy a stock because I think it's undervalued, I'm doing so because I think at some point Mr. Market will fully value it. My exit strategy is all about finding out at what point that will happen, and what I'll do when it does.

That's why for most -- but not all -- of my holdings, I have a general target in mind of when I'd like to sell it. If I pull the trigger on an attractive stock at $10, but I think it's true value is somewhere closer to $15, then chances are if and when it hits that point, I'll get out.

Of course, a lot can happen that might change my projected exit strategy. The main one being when the underlying business's situation has changed. If I thought it was a $15 stock but two years later it's performance is even better, I'd consider holding it until it reaches $20, or whatever else. But If I bought it at $10, planned to hold it until it hits $15, but it's prospects take a turn for the worse when it's trading at, say, $11 or $12 (or $1 or $25, for that matter) you'd better believe I'll get out when the light turns yellow.

As with anything else, exit strategies aren't, and shouldn't be, written in stone. But it's sensible planning to give some thought to how and why you might divest your holdings every time you find yourself buying into a new position.

1 comment:

Mr. Cheap said...

I'm grappling with the same issue myself ( I'm currently thinking about buying "Canadian Dividend Aristocrats" when they're yield is at 4% or higher, and selling them if they ever drop to 3% or lower.

Many dividend investors focus on the buy side as you say and basically decide to "hold forever". There has to be a point where you deal with a turn for the worse or cash-out on something that's over-valued (and buy lots of something else that's undervalued).