Hold or Sell?

There's a discussion going on in our Just Covered Calls Yahoo group about the pros and cons of holding a position that has declined in value vs selling at a loss and moving on to establish a new position.

Let me explain my views on this by using Ben Graham's concept of Mr. Market.

Let's say you own a private company that is fundamentally sound and produces enough free cash flow, after expenses, every year, which provides sufficient income for you to live comfortably.

Enter Mr. Market, a manic depressive who suffers from extreme highs and extreme lows. Each day, he comes to your office and offers to buy your company. On his extreme high days, he's feeling very optimistic and offers to buy your company at a very high price. On his extreme low days, he's feeling very pessimistic and offers to buy your company at a very low price.

Now, obviously, if he's offering a very high price, especially one that compensates you for the companys future cash flow potential, you might accept his offer. However, if he offers you a very low price, what would you do? Would you sell at a loss and start a new company? Or would you reject his offer, knowing that your company will still provide you with sufficient income? I bet you'll probably reject his low offer. Since the company is meeting your income requirements, this provides you the luxury of holding out for a better price.

Investing in stocks, using an income model (see previous article), is no different, since stock represents partial ownership in a company.