The 3 Good Reasons to Sell a Stock, No. 1: The Fundamentals Have Changed

In this episode of Motley Fool Answers, hosts Robert Brokamp and Alison Southwick want to focus on one question -- but it's a big one, especially for long-term investors: When should you sell a stock? To provide the answer, they've tapped Motley Fool Chief Investment Officer Andy Cross and Ron Gross, the advisor for Motley Fool Total Income.

In this segment, they talk about the first of three good reasons: The fundamentals of the business are no longer the same as they were when you bought the stock -- and not in a good way. They discuss competition, paradigm shifts, valuation, and more.

A full transcript follows the video.

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This video was recorded on Aug. 14, 2018.

Andy Cross: Now, the reason we're here is there's a big, old "but." There are times and reasons to sell, so let's get to it.

Ron Gross: We've broken the reasons down into three buckets, and the first bucket is the fundamentals of the company. If the fundamentals of a company either have deteriorated or you believe they are going to deteriorate, it certainly is one reason to look at maybe not owning that company. This could be revenues declining, margins are declining, profit is either declining or now there's a loss at the company. Any of those reasons that would indicate to you that profits could be coming down in the future -- it may not be a company that you want to own.

Competitive landscape -- obviously, if a new competitor comes into a marketplace or if an existing competitor ends up having the upper hand. You own a company that is not going to be a market-share grabber in the future. The market share is going to continue to deteriorate and that will hit the fundamentals. That will hit profits and again may not be a company that you want to own.

A platform shift threatens an investment. This is a really interesting one. We were talking about Netflix as a good example of a game-changer.

Cross: The cloud [represents] a platform shift. Look at IBM before they started making a push. Oracle making a big push in the cloud before they were all on-premise.

Gross: Perhaps some of you have heard of Kodak. That was a company that did not benefit from a shift. They did not shift. These are typically big, trending ideas [paradigm-shifting trends] that would be good if we could all recognize them. Sometimes we recognize these a little late, but still better late than never.

A stock is extremely overvalued. We're going to continue to bring up this concept of valuation, because it is somewhat controversial. I think it's fair to say we think it is appropriate if a company is really and truly undervalued such that no matter what you do, the fundamentals don't make sense in terms of where this stock is selling. From a Foolish perspective in that case, alone, we would recommend selling based on valuation.

Value investors like me get a little dicier about it all, but that's really a Foolish principle, and even David Gardner would say perhaps that's not even correct, because he loves a stock the most when Wall Street idiots like me are saying, "overvalued."

Cross: Something we didn't mention, but you know if you follow Tom pretty closely, is you don't have to sell down your entire position. If you go to the Everlasting Portfolio, you will see one share of Intuit. You will see one share of MSC Industrial. We have kept one share. That's to the extreme and not everyone wants to do that, but you also don't have to sell out of a complete position. If you really think it's extremely overvalued and you're just not comfortable with it, you don't have to sell the entire thing. You can pare back a little bit, too. We can take more questions about valuation because it is a fun topic to discuss.

Alison Southwick has no position in any of the stocks mentioned. Andy Cross owns shares of NFLX. Robert Brokamp, CFP has no position in any of the stocks mentioned. Ron Gross has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends INTU and NFLX. The Motley Fool owns shares of MSM and ORCL and has the following options: long January 2020 $30 calls on ORCL. The Motley Fool has a disclosure policy.