When to Sell, or How to Boil a Frog

Drawing of frog being boiled
The investor’s first concern must be to survive; that is, not to lose a lot of money. I mean in real terms, not quotational terms. The market rises and sets all the time. Don’t worry too much about that. So does the sun. Truly losing money is when an asset you own falls apart. That’s like your barn burning down: Something really bad has happened to you. It’s holding on to a stock in the face of deterioration in the company that can cost you a packet. I am told that if you place a frog in a pan of cool water and warm it ever so slowly over the stove, Mr. Frog never makes up its mind to jump out of the pan, and so gets boiled. If, on the contrary, you drop a frog into the pan of boiling water, it of course leaps out instantly. Usually a company, or an investment theme, decays little by little. You have ample time to get out, if you just start. Don’t let yourself get slowly boiled!

A shareholder has one big thing working for him, the underlying buildup in value—through retained earnings—of a company he owns. But many things work against him: adverse changes in the company, such as slack management or aging products; or in the industry, such as intensified competition or technological obsolescence; or in the country, in the form of heavier regulation and taxes, rising inflation, or political instability. Do worry about those hazards, if they are authentic and not yet reflected in the stock price. You may be sliding into a lower multiple of sagging earnings as the “glamour” aura wears off: the double play in reverse.

An extreme form is what I call the sol y sombra effect. In a bull ring, some seats are in the shade all afternoon, some in the sun, and some pass from sun into shade as the afternoon wears on. Similarly in a bull market, little-known stocks and new countries boom as they become “investable,” but as late afternoon advances, they pass into shadow and the bids dry up completely. It’s like musical chairs. So don’t get stuck with doubtful speculations going into a bear market.

Another good reason to sell is because the reasons why you bought are no longer valid: A value stock has risen to the point where it has ceased to be good value, or a growth company’s growth starts slowing.

When Not to Sell

Nevertheless, beware rumors of slowing growth or other troubles. They are always around, and if wrong, they become very expensive to follow. Wait for the worry to start actually happening: events, or management action, may forestall its occurrence.

There are two more times not to sell. First, solely because a great growth stock has risen splendidly. The big question is never what has the stock done, but how the company is doing. If it’s booming along and gives every promise of continuing to do so, and if the stock is still attractive on an earnings basis, then certainly don’t sell, unless it has become so big a part of your capital that it keeps you awake.

The second bad reason to sell is the opposite: solely because a stock has gone down. Some pundits advise selling if a stock declines 10 percent from your cost. Ridiculous! Either you understand the company or you don’t. If you don’t, you shouldn’t own it. If you do, and if the decline is a typical market jiggle, then the logical maneuver is, if anything, to buy a bit more. If you’re going to sell every time the stock goes down, you will never win, any more than a general who always retreats when the enemy advances. Assuming the fundamentals haven’t changed, the decline may have turned your stock into a screaming buy.

Indeed, to sell a stock you understand just because it has gone down is an act of utter irrationality. It’s as though after careful consideration you bought one of my perfect Labrador pups for $500, and at the same time let it be known that if anybody wanted her for $300, you’d part with her again at that price.


Professionals say that the market climbs a wall of fear. Quite true! If there’s no fear in a stock, or a market, a decline may be imminent. What you have to establish is whether there’s enough basis for that fear. If there isn’t, the rocket is poised for a flight upward. The easiest case is the bottom of a recession, when the government is cutting interest rates, the inventory pipeline is all but empty, plant capacity utilization is down, and everybody feels awful. From that level, the next move is almost certainly up. At least it has been every few years for the last half century.

And specifically, never sell on a war scare. After its initial shock, the market always recovers. War is inflationary, and thus bearish for money. Things, including things represented by stocks, rise against cash in wartime.

High Capital-Gains Tax Liabilities

Older investors often feel—or are told—that they are locked in by high potential capital-gains tax liabilities, and Grandma’s ancient steels, utilities, and rail stocks remain mired in the Slough of Despond. What to do? It;s like the serve in tennis: How hard you should hit is a function of how successful you are. A good investor should work off the dead position by degrees, hoping to pay the tax within a year or two by moving into something dynamic. You are better off switching during a market drop, when your stock—or its tax—are lower, along with the proposed purchase price.

Trust officers may not be too unhappy with a porfolio supposed congealed by high tax liabilities, since it gives an excuse for doing nothing while collecting the same fees. And of course immobilism is a much better policy than unsuccessful chipping and chopping. ■

excerpted from The Craft of Investing