If you own Apple or Tesla stock, first of all, congratulations! Your Apple holding grew 77% last year. As if that weren’t astounding enough, Tesla’s stock price soared 720%.
The gains you experienced in such a short period of time holding either of these stocks are truly record-breaking. I’m not interested in debating whether you were an investment genius or merely a very lucky bystander. But I do have a question for you: What are you planning to do with your stock now?
Keeping the stock is the easiest thing to do, because it involves doing nothing. But consider this: Would you buy it at today’s price if you weren’t holding it? If the answer is no, then why would you keep it? Holding a stock you already own – ignoring the tax consequences – is identical to selling it and then buying it back at today’s lofty price.
If you wouldn’t buy it today, it wouldn’t make any sense to hold it today, either.
You might also think about how you plan to use the unexpected gain (“unexpected” meaning how much more the stock appreciated as compared to its asset class). As an example, suppose you had invested $10,000 in Tesla stock at the beginning of 2020. The Standard & Poor’s 500 grew approximately 15% last year, which would have provided you with a gain of $1,500. Tesla’s gain on that $10,000, on the other hand, would have been $72,000. Therefore, the unexpected gain would have been $72,000 minus $1,500, or $70,500.
What would you like to do with that extra $70,000? Buy a Tesla Model S? (That might strike you as being rather fitting.) Save it for your child’s college education? Save it for your own retirement to increase the likelihood that you don’t run out of money?
In the first case, you’ll have to sell all the stock. In the other cases, be aware that Tesla’s current price/earnings (P/E) ratio is around 200, and the historical P/E ratio of large company stocks has been in the 12-25 range. Unless company earnings take off with the same trajectory as Tesla’s stock price has just done, its stock price could plunge as much as 90% or more if its P/E ratio returns to a value even remotely close to the historical mean.
When to take your chips off the table
Imagine that happening right before you need to cash it out to start paying for school. Or when you’re about to retire. And if you don’t believe stocks with excessively high P/E ratios tend to return to the mean eventually, think of it another way: Which seems more likely, a further 50% growth on top of a 720% increase – a total gain of more than 10 times its value one year ago – or a decline of 50%, reducing the total gain to “merely” four times its previous price?
At our firm, we usually recommend limiting any individual stock holding to less than 10% of the value of one’s overall portfolio. But most clients are able to achieve their future goals without having to deal with the volatility engendered by holding single stocks at all. Diversified mutual funds spanning entire asset classes such as the S&P 500 generally provide the needed level of growth with much less investment risk.
If you’re truly investing in Apple, Tesla or any other individual stocks just for fun because you have enough other savings to cover all your current and future needs and goals, congratulations again! Remember, though, that even gamblers recognize when it’s time to take some chips off the table.
Los Altos resident Artie Green is a Certified Financial Planner and principal at Cognizant Wealth Advisors. For more information, email [email protected] or visit cognizantwealth.com.