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When Is the Best Time to Sell a Stock?

Deciding when to sell a stock has to be one of the hardest decisions investors need to make. Deciding when to buy a stock is easy. Investors rarely ever have an obligation to buy a security, so you only need to look at the companies you understand. If you don't understand the business, it's pretty easy and straightforward to say "no" to buying.

A different matter

Selling is a different matter altogether. You already own the position, so you need to make a decision. It can be just as hard to take profits and move on as it is to cut your losses and admit you were wrong.

One strategy I like to use is to set out the sale scenarios before I buy a position. That why I know what I'm looking for, and it helps build my understanding of the business in the research process.

According to the Oracle of Omaha, Warren Buffett (Trades, Portfolio), the best time to sell a stock is when the underlying fundamentals of the business have changed.

Speaking at the 2002 Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) annual shareholder meeting, Buffett said that he used to buy and sell stocks when they reached a certain profit target, and then moved on to selling when he found something more attractive, to avoid having to borrow money.

"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."

However, in the early 2000s, when Berkshire had more money to spend than Buffett had ideas, this wasn't a problem. Instead, Buffett's selling process began to be defined by the stock in question's economic prospects.

As Buffett explained in 2002:

"So now we sell -- really when we think that we've -- when we're reevaluating the economic characteristics of the business. In other words, if you take the -- don't want to name names -- but take a stock we've sold, of some sort.

We probably had one view of the long-term competitive advantage of the company at the time we bought it, and we may have modified that.

That doesn't mean we think that the company is going into some disastrous period or anything remotely like that. We think McDonald's has a fine future. We think Disney has a fine future. And there are others.

But we probably don't think that their competitive advantage is as strong as we might have thought -- as we thought it was -- when we initially made the decision."

Like so many other different aspects of investing, unfortunately, there is no short cut you can use when deciding if it is time to sell a stock or not. It all comes back to your understanding of the business and its long-term prospects.

This is one of the main drawbacks of buy and hold investing. It requires a huge amount of time and effort to understand the businesses you own. Simply buying and forgetting stocks is a recipe for disaster because you never know what's around the corner for any business, or if it will be able to maintain its competitive advantage.

Take the newspaper industry, for example. This is an industry that did have a huge moat, but this has since been eroded. As Buffett explained in 2002:

"I mean, in 1970, Charlie and I were looking at the newspaper business. We felt it was about as impregnable a franchise as could be found. We still think it's quite a business, but we do not think the franchise in 2002 is the same as it was in 1970."

Disclosure: The author owns shares in Berkshire Hathaway.

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This article first appeared on GuruFocus.