Monday, May 28, 2012

The Little Book That Builds Wealth: Chapter 14

Morningstar's equity research director authored this book on identifying companies with competitive advantages. Dorsey separates competitive advantages into four categories, providing a framework for understanding how wide a moat a company really has. The book is full of examples of companies Dorsey believes have moats, and the reasons why their moats are likely to last - or not!

In this the final chapter, Dorsey tackles the difficult subject of when to sell. Dorsey argues that there are only four right reasons to sell. Before you sell, the answer to one of the following questions must be a yes:

1) Did you make a mistake?
2) Has the company changed for the worse?
3) Is there a better place for your money?
4) Has the stock become too large a portion of your portfolio?

Unfortunately, we anchor ourselves to price and have a hard time selling at a loss even when it may be justifiable (based on the questions above) to sell. The author suggests a way to avoid anchoring: when you buy a stock, write down the reasons you bought it. If the company takes a turn for the worse, pull out your reasons and see if your reasons for buying are still intact.

Finally, avoid selling simply for price. Just because a stock has dropped does not mean you should sell!

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