investing

When to sell your investments

"Don't let the tax tail wag the investment dog," he says. "Investment decisions should ultimately control whether you buy or sell. At least wait until the end of the year when you know pretty well what your situation is in terms of gains or losses, and then you can start weighing the tax implications."

Be mindful, too, of the wash-sale rule, which prevents investors from artificially generating a loss for tax purposes by selling a stock and then buying it back within 30 days.

Look at price-earnings ratio

It also makes sense to evaluate each stock's performance rather than using a generic stop-loss system to sell if it falls below, say, 20 percent of your purchase price, says Paul Larson, equity strategist for Chicago-based mutual fund tracker Morningstar.

The readily available price-earnings, or P/E, ratio, the price of a company's share price divided by its earnings per share, is a good first step.

A stock's P/E ratio, often called its multiple, measures the level of confidence investors have in a company. The higher the quality of the company, based on profitability, growth rate and competitive advantage, the higher the ratio.

If a company's P/E ratio is 15, it means investors are willing to pay $15 for every $1 of earnings a company generates.

A company's multiple can be easily found on financial Web sites offering stock quotes, including Yahoo! Finance and Morningstar.com.

Historically, a reasonable ratio is anywhere from 15 to 30, depending on the industry. Anything higher could mean a stock is overvalued. Conversely, stocks with multiples of less than 15 (not uncommon in today's beaten-down market) are favored among bargain hunters.

Focus on cash flow

Another metric that can help determine whether a stock is relatively cheap or expensive is its cash flow multiple, or its market value compared to the amount of cash it generates.

The price-to-cash-flow ratio is not widely reported, but it is easy to calculate and some believe a better barometer of a stock's true value.

Simply divide the stock's market capitalization by its free cash flow for the most recent fiscal year, which can be found in the company's earnings reports.

Like the P/E ratio, a company's market capitalization can be obtained by typing in its ticker symbol in the stock quote field of most investment Web sites.

If the free cash flow ratio is higher than that of other companies in the same industry, it's expensive and may be overvalued. If the multiple is lower than that of its peers, it's cheaper and may be undervalued.

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"When a stock is trading well above its estimated intrinsic value of all future cash flows, that's a good time to consider selling," says Larson.

Beware the outliers

Another reason to sound the alarm on a particular stock or fund is when it consistently loses more than its peers -- not once or twice, but over a period of several years.

"This is not a red flag," says Larson. "It's a yellow flag. It's a chance to go out and do more research to find out what the market may be seeing that you are not. But remember, just because something is underperforming doesn't mean your initial (decision to own it) is wrong."

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