Warren Buffett: The ONLY 3 Times You Should Sell A Stock

Warren Buffett, the greatest of all time, says there's only three good reasons to sell a stock out of your portfolio. If you're selling for any other reason, you might be hurting your returns without even knowing it. Most people sell stocks for the wrong reasons. In this video, we're going to show you Warren Buffett's three simple rule checklists that can save you from painful investing mistakes. And guys, one of them could be that selling at a profit is actually hurting you. You've probably seen this before. A stock drops. Suddenly, everyone is screaming sell. After all, that's how stocks fall. The news gets loud. Your emotions kick in. But here's the truth. Selling just because a stock is down is not a strategy. It is a reaction. It's a reaction emotionally. And it's how investors lose a lot of money. Warren Buffett, arguably the most successful long-term investor ever, follows a different plan. He sells only when one of these three things happen. So let's walk through them now with real examples so you can invest smarter and sleep better. Reason number one, and I've had this occur and I'm going to talk about that at length here, your original thesis was a mistake. Now guys, this one is a must-learn if you're serious about becoming a great investor. Buffett sells when he realizes he made a mistake in his original thesis. And let me be crystal clear here. That doesn't mean the company is garbage. You could have bought a garbage company for the right reason. As example, the stamp company that Buffett and Munger bought back in the early seventies. They bought it knowing full well that the revenue is going to continue falling. And over the next 13 years, revenue fell 99.9%. 99.9% from over a hundred million dollars in revenue down to $120,000 in revenue. But guess what? They thought that was going to happen and they still made 15% return on their money. The thesis changing means the original reason you bought it no longer holds up. So you might be wondering, well, how did they make 15% return on their money? Well, that company, the blue chip stamp company had a portfolio of stocks that was worth a lot of money. And if that portfolio had been something different than they originally expected, they would have sold, but they were in there for the portfolio, not for the business. If you also remember back in 2011, Buffett started buying IBM. He thought it was a solid entrenched tech company with deep roots in big businesses. He had a great balance sheet at the time, strong relationships and recurring revenue, things that he loves. He believed they could successfully pivot into all the areas that they needed to do like cloud computing and keep up with the changing tech landscaping. But over the next few years, it became clear they weren't evolving fast enough. Competitors like Microsoft, Amazon, Google were all eating their lunch. IBM's growth slowed, innovation lagged, and the moat started to go away. So what did Buffett do? He didn't hold on and hope. He didn't justify it by saying, well, it's IBM, they'll figure it out. No, he said it straight. I was wrong. IBM is a big, strong company, but they're not going to do the job I thought they would. Boom, thesis broken, time to move on. And this is exactly where Buffett shines. He doesn't fall in love with the stock. He falls in love with being right about long-term value. If he's wrong, admits it, no ego, no emotion, move on. Charlie Munger has said this forever, if the facts change, we change our minds. Guys, that's not weakness, that's strength. That's how you protect your money. Sometimes the mistake is about management, sometimes about the product. Sometimes it's just that you overestimated the company's ability to grow. And let's be honest, sometimes fraud or hidden risks force your hand. That's okay. Mistakes happen. If you're investing for a long period of time, you'll be lucky to be wrong only 40% of the time. You'd be one of the best investors to be wrong only 40% of the time. What matters is this, when you realize that your original thoughts, your original thesis is wrong, do you fix it or do you freeze and hope? Well, the only way to fix it on publicly traded companies is to move on. You can't go to the company and become the CEO. You can't go in there and lead a new team. You have to vote with your dollars and that means selling. Every dollar you keep tied up in a broken investment is a dollar that's not compounding somewhere better. Buffett knows this. That's why he cuts his losses and reallocates into better opportunities. He doesn't care how big his position was or how famous the company is. He cares whether the future makes sense at today's price. Now, some of you might be thinking, well, Paul, he's the one that always says, if I liked the company, the stock falls, then wouldn't he like it more? It's not about the stock price. It's about the thesis. If he bought it for a certain reason and the stock goes down and that reason is still intact, you buy more of it. We're talking here about the reason being gone, the thesis being wrong. That's what's so important. So here is your mental checklist. Is the business still what I thought it was? Is the future as bright or has something changed? Is the price to value still the same? Would I buy the stock again today if I had no position knowing what I know now? This is how you should make those decisions. But sometimes we get a little stuck in the investment we've made. If the answer to any of those questions is no, then your job is clear. Sell, regroup, move on. You didn't fail, you learned. And guys, stick around to the end of this video because I'm going to show you a strategy I use when selling a stock that can actually generate a little income on the way out. So you can actually be paid to sell a stock. Guys, my personal example of when my thesis was wrong, there are several, but one is Carnival Cruise Line. The reason I talk about Carnival Cruise Line is I actually made money and then realized my thesis was wrong. So I got out as fast as I could saying I was wrong, let me move on. And guess what? The stock's actually higher than when I sold it. So maybe my thesis was right in the first place, but my thesis was that they were coming out of COVID. And I thought, you know what, they're going to issue a lot of shares and they're going to take on debt. But I don't think they're going to take on, I thought there was a certain level of shares they would issue, a certain level of debt. And they went well past that level. So once I realized that was happening, I did not trust my thesis originally, and I sold the second I could. And along the way, I made some money in covered calls, which we'll get to later, but I also sold the stock at a profit, luckily. This is not some humblebrag. This is me literally saying that's going to happen to you at times. Don't confuse being up on a stock and being right. That's the reason I show this example. That's very, very important as to why I talk about this example. Because a lot of people out there would say, wait, you're up on it, you're right. No, just like if a stock goes down, it does not make you wrong. Stocks go up and down because of the emotions of the market. Our fourth tenet of our principle-driven investing is in the short run, stocks are a voting machine. In the long run, they're a weighing machine. I don't know where a stock is going to go in the short run. If it happens to go up in a time I realized I was wrong, I get the F out of there. That's the key. Reason number two for the stock to be sold. The price has run so far ahead of business value that it no longer makes sense to hold. Guys, this to me is the hardest one. The reason being is I've become more of the person of buying a company that I want to have for as long as possible. But at some point, there will be a point where maybe the stock is massively overpriced. One, for example, would be Munker has said he will never sell Costco. Guys, I look at Costco and I look at this, 58 times free cashflow, 54 times earnings. And guess what? I don't see where the value is there. This is a company that's going to grow four or 5% a year. Look at analyst estimates here. Revenue growth. Okay. A little bit higher than I expected, but for a company selling for 50 times earnings and 57 times free cashflow, we need a much faster growth rate. Is Costco a premium company? Absolutely. But at some point you're going to say, is it too much? Let me be very clear though. This doesn't mean the company is bad. A good investor knows the difference between the company and the stock price. The business might be firing in all cylinders. And guys, all indications are that Costco is firing in all cylinders, but if the price gets too far ahead, if it starts to reflect too much of the future value today, where is your juice there? It's very difficult to get more squeeze there. Now, guys, let's say you bought a luxury watch and I love watches. So that's why I talk about this. Let's say it's $5,000. You love it. It's stylish. And we just came out of COVID and all these Bitcoiners start buying watches like crazy. Someone suddenly offers you $20,000 for that same watch. You could hold onto it and pretend you're not, you're emotionally attached to it. But let's be honest. You'd probably say, yeah, I'll take that 15K in profit. That's not disloyalty. That's smart. Why? Because a watch is easy to replace. You can go buy another watch or several watches to replace that one watch that you love. With investing, it's hard to find another Costco. So make sure if you're selling it so far out of that it's absurdly out of value. Because these companies can keep going up in price and price and price as the fundamentals catch up. I have sold great companies because they went up too fast and regretted it many, many times. That is an issue that the company just keeps on growing. And by the time the stock does come back, the price, the intrinsic value has gone way past the point you even sold. I hope that makes sense to you. I want you to understand that. If you sold a stock at 50 because you thought it was worth 40, and by the time you were able to buy back in, it went to 200, you'd be like, oh damn, even though the company's worth 140 to you. Well, guess what? That happened with me and Microsoft back 13 years ago. I bought Microsoft in the teens and early 20s per share when everyone was like, that's crazy, Microsoft's dead. I sold it at 60 because I thought it was worth 50. I've never bought back in. And now my intrinsic value in Microsoft is well into the 200s, maybe even $300 per share. That was a major mistake. Just holding onto it would have said, you know what? It's a little overpriced, but one, that's okay. And two, it kind of deserves it. And I can just ride it on up. If the price gets so egregious, $60 worth of $50 is not egregious. If I thought it was worth 50 and it was selling for 500, that's egregious. Even 200, that's egregious. I don't know the exact right time, but if the valuation gets so egregious, it's actually going to go into our third reason why you sell as a combination. Buffett has sold plenty of great businesses over the years, not because they were failing, but because the price got silly. He has said it many, many times. The market is there to serve you, not instruct you. If someone wants to pay way more for a stock than it's worth, don't argue, just let them. Now guys, the third reason has to do with the second reason, opportunity cost. If you have your money invested and one of your stocks has gotten so absurdly expensive that you want to sell it because you found something absurdly cheap, that's a reason to sell. Remember, if you're selling a company like Costco, where the future returns, let's go pull up our stock analyzer tool. And let's look at the last time I did Costco, because I want to see what my future returns are based on today's price. Based on today's price, we're looking at negative, negative, and 2.5% returns total, even on the rosiest of assumptions. So I'm looking at this, if my numbers are correct, my assumptions are correct above, paying today's price and the best of assumptions, I can look at about 2.5% return per year over the next 10 years. Now, then let's say you have another stock. And one example of the company that I think has a lot of potential is Southwest Airlines. Let's pull up Southwest Airlines. It's a tough industry, but I think this company has a lot of potential. Look at these potentials, 14, 23, and 32% based on today's pricing. Again, I own Southwest, doesn't mean you should go buy it because of this. There's reasons why I own it. But if you have a company that's fully mature and your best case scenario is a few percentage points or another company with a lot more upside potential, that's when you sell one to buy the other. Opportunity cost is a superpower in investing. That is Charlie Munger's famous line. He's always about what is the opportunity cost today. It means that every dollar you got invested as a soldier, that soldier needs to be deployed. We'll earn the highest return right now. If you have money sitting in a fully valued stock and you find a better deal elsewhere, guess what? It might be time to move that soldier to more profitable battlefield. This isn't about emotions. It's not about I'm bored or the stock feels stale. It's about using principles to constantly make sure your capital is working efficiently. Selling isn't giving up. In this situation, selling is an upgrade. You sold a company that's phenomenal for a company that's a little more troubled, but that's where you find the value is when people misprice things. Let's say you own that Costco, solid company, great cash flow, great moat, and it's up a ton. But now you find another business trading at a steep discount with better prospects for the future and a bigger upside to today's price. What do you do? Well, Buffett would say the best thing a person can do is to invest in a wonderful business at a fair price. But if you can invest in a wonderful business at a wonderful price, even better. Southwest is in a tough industry, but it's a business in a tough industry. Buffett necessarily wouldn't agree with that statement. He believes the industry wins out in the end. But I look at Southwest saying, this is a company that for 48 years did a great job making money. They've hit a few years of roughness. If they get back to half their profitability, this is a multi-bagger. Buffett is constantly evaluating new ideas. And he's constantly asking, where does my next dollar get the highest return? If the answer isn't in your current holdings and you don't have new cash coming in to deploy, then yes, it may be time to sell. Ideal world is you have more cash coming in, you can deploy it in both ideas. But here's the part most people forget. You're always making a choice. Even doing nothing is a choice. Holding a stock that's fairly valued or even overvalued just because you already own it, not necessarily a great reason. In fact, many people would say it's a bad reason. Imagine you own a rental property that gives you a 6% return, but suddenly your neighbor wants to sell you his identical property for half the price, meaning you could make 12 or 15% annually. Are you going to sit there and say, nah, I'm loyal to my first one? Of course not. You would try to sell yours at fair market. Maybe your neighbor needs out quick and you're the only person that can give it to them. You would sell yours, buy theirs. Buffett has done this plenty of times. One of his most famous examples was he rotated out of a big position like IBM and went into Apple. He wasn't emotional about it. He didn't try to squeeze the last penny out of a stock. He moved on when something better came along. Charlie Munger drives this home all the time. He says, spend each day trying to be a little wiser than you were when you woke up. If you're not learning, you're dying. And that is exactly why Buffett and Munger always read, study, and reevaluate. Not just what they own, but what they could own. It's why we talk about learning right now. It's why we talk about our software. It's about understanding what's out there because eventually there will be a price that makes sense. That's why I have my watch list here of all my companies and the prices I want to buy them at. That way, when they do hit those prices, I can get notified. When I have a better opportunity, a higher expected return for the lower risk, you owe it to yourself to make the switch. That's not impulsive. That's intelligent capital allocation. Now guys, there is a fourth reason some people would tell you to sell. It's because of diversification. A position you have has become too big of a part of our portfolio. I agree with this and I don't agree with this. The reason I agree with it is, let's say you bought Nvidia 15 years ago. In all likelihood, if you wrote it all the way up, it is an exorbitant part of your portfolio. That's a lot to have in one company. But if it's a great company at a fair price, got to let it ride. That's how you make the big money. That's how you outperform. The reason why mutual funds can't outperform, it's because they have to sell stocks that become too big a part of their portfolio. They can't have more than 5% of their portfolio in one stock. So when a winner is running, you have to keep, stop selling parts of it. That's not how you beat the market. And that's the problem. For you personally, it is very difficult to have 20, 30, 40, 50% of your money into one stock. By the end of the day, if it's undervalued, what are we doing here? I don't know. Me personally, I don't feel comfortable with that either, unless I had a company that just grew over multiple decades to be a big part of my money. And even then, I would probably sell as good opportunities came along. Because for it to be up 20, 30, 40 times, at some point, it was probably overvalued. But here's the fun part. If you ever choose to sell your stock, there's a way to make money selling your stock. This is where covered calls come in. Here's the basic idea. If you own 100 shares of a stock, you can sell a call option on those shares, usually 30 or 45 days out at a price above where it's currently selling. So what's a call option? It's an option, you sell somebody the right to call the stock away from them, away from you. So as an example, let's say you own Costco. And let's say it's selling for $9.50 today. You might say to somebody, hey, I'll tell you what, in a month, call it August, some Friday in August, let's call it August 21st, even though it's not a Friday. I will let you buy Costco from me at $1,000. And for that right, I'm going to charge you five bucks. Okay, so what does that mean? You're getting $5 today. If between now and August 21st, the stock stays under 1,000 bucks, you keep your $5, you keep your stock, you're good. So you keep your five bucks, you made half a percent for one month. Great. Now, what happens if it goes above, let's say it goes up 1,050. Well, you get to keep everything from 950 to 1,000. So you keep $50 of profit, you get to keep the $5, but now you got to sell the stock to them for 1,000 bucks. So you lose out on the difference here, the extra gain, the $50 in gain here. But you got $5, so you essentially lost out on $45 in gains. You didn't lose $45, you just missed out on $45 in gains. I won't get into the exact math here about the call price versus the stock, but at the end of the day is you're allowing yourself to get paid to sell stock. But here's where it gets better. Let's actually pull up Costco, because I want to pull up the exact example here to show you exactly what it would look like. Now, guys, in full disclosure, I absolutely guessed, and I happen to be right, that for August 22nd, the $1,000 call option was $5.20. Complete dumb luck. I was just guessing. I'm not trying to take credit for that. But Costco right now is selling for $948. Let's say you're like, I want to sell it at $950. Guess what? $950, you can get $22 per share. $22 per share. If it finishes above $950, you get your 22 bucks and your extra $1.50 in gain. So you get $23.50. Now, if it goes down from here, you keep your shares and you keep your $22. But guess what? If it goes down from here, you're okay, because you're like, hey, I'm fine keeping it under this. I'm not fine keeping it over that. Guys, this is 3% return in one month. Because $22, it's like 2.5% return over one month. You do that over and over, you're adding 30%. Hell, you can go even crazier. You know what? I'll sell it if it's above $925. You sell a call, that's what's called in the money. $925, you can get $36 to $40 per share. Now, if it's above $925, you lose the shares. So in all likelihood, chances are about 30% chance that you keep it, 70% chance you'll lose the shares. If it falls below $925, you still got 36 bucks. You get to keep that money the entire time. It's your money. If it falls below $925, you keep the shares and your $37. This was an absolute game changer for me. Guys, I wish I knew this 20 years ago. The great part about this, especially when selling a stock is, you either get more money and keep the stock because it went lower, or you get a lot of money and you sell this, get rid of the stock that you're going to sell anyhow. What could be better? Does it sound like a free lunch? Yes, but it's not a free lunch. It's not at all, because people then get too aggressive and get emotional about it. That's how you talk about it this way. And by the way, Warren Buffett does this just as much as everybody else. He does this on the buy side and the sell side. He does this because it's a great way to generate income. The strategy is simple, logical, and even more important, it's consistent with value investing. You're not gambling. You're managing your exit risk and boosting your returns. So instead of rushing for the door, consider easing out while collecting rent along the way. Collect that income. It's smart and it's disciplined. Guys, if that makes sense to you, I want you to do me a favor. If you want to learn more about that, we have a free PDF on options that will be sent to you in a matter of minutes. Click the link below, go sign up. You will get the PDF free of charge within one minute. It's an absolute game changer. Even if you don't have 100 shares of any stock, you got to learn how to do it because there is a way to do it on less shares as well. But guys, absolute game changer. If you literally said to me, Paul, in business, you could change one thing you've done, go back 20, 25 years and teach yourself that, it would be this. That's how important this is for me. And listen, knowing when to sell is only half the battle. You cannot make smart selling decisions if you don't know what a stock is actually worth in the first place. That's why our full course is so important. That's why understanding the stock analyzer tool that we had before is so incredibly important. This thing will give you a way of merging the story and the numbers together. The truth is, if you don't know how to value a business, you won't know when it's overvalued, you won't know when it's undervalued, and you won't know when it's fairly priced. You're not going to recognize when your thesis is broken or when there's a better opportunity elsewhere, and that's going to be a problem. Valuation is the foundation of all three selling reasons that we just talked about. So if you really want to invest like Buffett, not even invest exactly like him, just get closer to him, and not just guess like the 99% of people out there, watch the video linked on the screen. We'll walk you step-by-step through how to value a stock, what to pay for it, and how to think like a long-term investor. Thank you for your time.