Reasons To Sell a Stock #1: Thesis Is Not Intact

By Markets Fool.com

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We strongly believe in holding stocks at The Motley Fool, and buying companies for the long term. Still, there are times when it's completely appropriate for long-term investors to sell a stock -- like when their investment thesis is no longer intact.

In this clip from Industry Focus: Tech, Dylan Lewis and David Kretzmann talk about what it looks like when an investment thesis breaks down, some advice for reevaluating your investment in light of foundation-shifting changes in a company, and some signs that your money might be better invested elsewhere.

Check out other reasons to sell a stock:

A full transcript follows the video.

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This podcast was recorded on Aug. 26, 2016.

Dylan Lewis: Reason No. 1: The thesis is no longer intact. I have an example from my own portfolio. It isn't a time that I sold, but it's a time that maybe I would have considered selling, had circumstances been a little different. I realize that is not the same thing, but I think it's an interesting way to illustrate this.

People that listen to the show might know that I'm a bit of aTASER [International](NASDAQ: TASR) bull. I like the company quite a bit. I've talked about them plenty of times on the show in the past. My thesis with them has always been their core weapons segment is nice, but for me, the big growth opportunity is with their Axon body-camera line, the Evidence.com cloud storage business. And that's proven out so far. Over the last two quarters, the Axon revenue has been higher than their weapons revenue, and the bookings for the segment has grown over triple digits year over year. So it's looking good.

During some of that same period, the company has sold off dramatically after reporting weak guidance. Some of that was due to a worse margin look, because of some of the changing product mix there. Some of it was due to some higher SG&A -- selling, general, and administrative costs -- which might have eaten into earnings a little bit.But the indicators for that Axon segment were strong. They'd beaten what they'd forecast for bookings, they've been continuing to add major contracts. Things were looking good there.

If the results had been flipped, and they'd offered great guidance but the Axon segment -- which was my thesis going in -- had not been performing well, and they'd been missing the mark on their forecasts, and they hadn't been able to lock up some of these really important contracts, that's a circumstance where I'd consider selling the stock, because it's counter to what I'm expecting and what I'm looking for. Granted, sometimes you're right for the wrong reason. But I think that's an example of, you expect a certain thing, and you're buying into a certain story, and if it doesn't play out, and that's a hypothetical there, as a way to illustrate that.

David Kretzmann:Yeah, I think that's a great example. It's something that Peter Lynch, great investor who we talk about a lot at The Motley Fool, something he references as a yellow flag, or potentially a red flag, is if a company de-worsifies. This happens a lot with acquisitions. Let's go far out here with an example. If you haveCoca-Colago out and say, "To spur growth, we're going to buy a timber company."

Lewis:A little head-scratcher there.

Kretzmann:Right, something like that. Especially if a company is relying on acquisitions to make growth, if they start venturing outside of their core competency, where they have a competitive advantage, or where they have knowledge with that industry or segment, that's a yellow flag that the company is stretching to find growth.

Lewis:And that's getting outside of why you're investing in that company.

Kretzmann:Exactly. You're not investing in Coca-Cola to get exposure to the lumber markets. That's obviously an extreme example, but it's something to watch for, especially with an acquisitive company.

Another example here that I'll quickly go into isRetailMeNot(NASDAQ: SALE). This was a digital coupons provider. It's still around. Going back to 2012, 2013, this was a company that growing annual sales well above 40% per year. It was growing very quickly; it was a growth story. Then, in 2014,Googlechanged its search algorithm, organic traffic to RetailMeNot's platform plunged because they relied on organic traffic through someone searching for a coupon on Google and getting redirected to RetailMeNot. That's how they got the bulk of their traffic. Suddenly this went from a growth story to a turnaround story, because the company's desktop traffic plunged, it was actually dropping, and that's where the bulk of their ad revenue was coming from, from their desktop business. Their mobile business was still growing, but it was such a marginal portion of the business that it couldn't make up for the losses that they were seeing in that desktop segment.

Lewis:So you're seeing the profile of that business totally change.

Kretzmann:Exactly. You're going from a business that was growing sales 25% to 40%, or even more, each quarter, to a company that's all of a sudden seeing declining sales, a turnaround story, saying, "Can they bootstrap and make that mobile segment a more prominent part of the business to make up for those losses?" That's a much different story than when you first bought into a growth company.

Lewis:And it can be kind of tough to accept that as someone that may have bought in early. But at a certain point, you're better off realizing that and deciding to do something else with that money.

Kretzmann:Yeah. At that point, you have to re-evaluate the thesis, because obviously, your original thesis isn't intact, if you thought the growth would continue. You basically just have to re-evaluate the thesis and say, "Going from today onward, do I think this is going to be a winning investment? Do I think it's going to beat the market? Does it have above-average chances to beat the market?" In those cases, you basically just have to start at square one and make a new thesis. And if you don't really believe in that thesis, it might be a good time to sell the stock.

Lewis:And re-evaluating the business really is the first step in deciding to sell. You can drop those in a little bit synonymously for this discussion. Selling is the final act of getting out of the position, but the considerations there are very similar.

David Kretzmann owns shares of RetailMeNot. Dylan Lewis owns shares of Taser International. The Motley Fool recommends Coca-Cola and Taser International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.