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The Best Reason to Sell a Stock According to Warren Buffett

Warren Buffett (Trades, Portfolio)'s recent decision to sell all of his airline stocks has attracted lots of attention, especially as these companies have seen their shares rally considerably since the sale.

But rather than attacking these moves, we should view them as case studies and insights into the Oracle of Omaha's investment strategy.

Why Buffett sells

At the 2002 Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) annual meeting, Buffett outlined the two main reasons he would sell a stock.

The first explanation given was, quite simply, that when a better idea comes along, it makes sense to liquidate a holding that appears to be a less attractive opportunity:

"We would sell if we needed money for something else, but that has not been the problem the last 10 or 15 years. Forty years ago my sales were all because I found something that I liked even better. I hated to sell what I sold, but I also didn't want to borrow money, so I would reluctantly sell something that I thought was terribly cheap to buy something that was even cheaper. Those were the times when I had more ideas than money. Now I've got more money than ideas, and that's a different equation."

The other reason why Buffett might sell, according to his statement in 2002, was that the "economic characteristics of the business" had changed. He said:

"We sell really when we think we're re-evaluating the economic characteristics of the business. We probably had one view of the long-term competitive advantage of the company at the time we've bought it, and we may have modified that. That doesn't mean that we think the company is going into some disastrous period or anything like that. We think McDonald's (NYSE:MCD) has a fine future, we think Disney (NYSE:DIS) has a fine future, and there are others. But we don't think their competitive advantage is as strong as we thought it was when we initially made the decision."

Analyzing the decisions

Rather than criticizing Buffett's decision to sell any stock, we should instead question what he thinks has changed with the company.

For example, toward the end of last year, Berkshire's 13F revealed the group had been selling part of its significant stake in Wells Fargo (NYSE:WFC).

Buffett had been reducing the holding gradually over the past several years to keep Berkshire's ownership stake below the critical 10% level. However, selling accelerated in the fourth quarter (although it didn't continue in the first quarter of 2020).

What could have pushed him to sell?

It could have been the fact that the bank's asset cap restricts its competitive advantage of size. It could also have been the fact that the bank's reputation, which was once sector-leading, has been significantly damaged by the false account scandal.

While either reason is plausible, Buffett has not explained why he decided to sell, so this is just speculation at this stage. Nonetheless, it can be helpful to review these deals to understand what's going on behind the scenes. The only way to improve your investment strategy is to develop and learn from others, not just mindlessly copy the actions of billionaires.

We need to understand the thinking behind the decision. That's the only way to improve over the long term. Doing something just because a billionaire or successful trader did can be a fast way to lose a lot of money.

Buying something you don't understand can lead to significant losses if the trade goes bad.

Looking back at Buffett's investment decisions is a great way to build an understanding of a successful investment strategy.

Disclosure: The author owns shares of Berkshire Hathaway and Wells Fargo.

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This article first appeared on GuruFocus.