It can be difficult knowing when to sell a stock, but fraud or a drastic pivot in the business model are as clear as they come.
September 22, 2021
One of the hardest parts about being a long-term investor is grappling with the question of when to sell.
Of course, the easy answer is “When your thesis is broken.” But even if you build a comprehensive thesis for each stock you own — which is exactly the purpose of the individual reports we’ve published for every stock recommendation on our 7investing scorecard to date — it can still be difficult distinguishing between temporary setbacks, for example, and permanent developments that have led to a truly broken thesis. And the nuance involved in finally deciding when to press that “sell” button really needs to be evaluated on a case-by-case basis.
However, in my mind there are two clear developments for any stock that make the decision to sell relatively easy: Fraud and drastic pivots (for the worse) in a business model.
The former — fraud — is the most clear-cut case for me personally. Fraud can come in many forms, whether it’s insider trading, fabricating financial results that require restatement later on (as in the recent case of Luckin Coffee, for instance), or lying about a product’s capabilities (the cases of Theranos and Nikola come to mind), fraudulent activity sets an almost impossibly high bar for winning back the trust of shareholders.
While it might be tempting in some cases to say something to the effect of, “Well, the fraud is no longer occurring and the stock is now undervalued!” — particularly if it involved an executive who’s no longer working for the business — in too many cases it either causes irreparable damage to the company or was indicative of more pervasive underlying problems.
Second, a more nuanced trigger that makes me want to sell is a significant pivot in the business model for the worst.
GoPro immediately comes to mind as a glaring example. While the action camera specialist was initially a market darling on the heels of its 2014 IPO — fueled by incredible demand for its flagship devices and, later on after the stock pulled back hard on waning demand for those devices, the promise of its Karma drone product in 2016. Many investors around that time were attracted to GoPro for its newfound optionality and potential incremental revenue in the multi-billion-dollar drone space. But GoPro subsequently discontinued the Karma drone and exited the drone market altogether in 2018, blaming a combination of steep competition and a hostile regulatory environment in the U.S. and Europe that it believed would ultimately reduce its total addressable market. Though GoPro has subsequently made some inroads with higher-margin digital services and subscriptions, its no surprise its stock has failed to revisit its post-IPO highs on the heels of its unfavorable business pivot — and investors who opted to sell soon after the pivot would have been far better off.
That’s also not to say all business pivots are unfavorable and should result in an automatic “sell” decision for their stocks. I’ve gone on record, for example, as being supportive of iRobot‘s moves several years ago to divest both its Defense & Security segment and its telepresence business in favor of honing its focus on the lucrative home robotics market. But in this case, the home robotics market is so vast and affords to much optionality to iRobot that such a pivot has turned out to be an overwhelmingly positive development for the company.
Still in the end, while making the decision to sell a stock is hardly straightforward, cases of fraud and unfavorable business pivots can make pulling the “sell” trigger far easier than it otherwise might have been.
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