(MONEY Magazine) – Should I sell my stock? It's the toughest question you face as an investor. And chances are you don't get the answer right as often as you would like. Individual investors routinely "sell winners too early and ride losers too long," wrote researchers Hersh M. Shefrin and Meir Statman in a 1985 Journal of Finance article. They concluded that investors often succumb to fears of loss and regret when making sell decisions. People who don't want to make paper losses "real" hold on to poor performers, and those who don't want to regret a missed opportunity for profits sell winners. A study last year by Terrance Odean, a professor at the University of California-Davis, supports this thesis. Odean analyzed the records of 10,000 accounts at a discount brokerage firm over a seven-year period that ended in 1993. The stocks that investors sold, Odean found, outperformed the stocks they kept by 3.4 percentage points during the following 12 months.

But don't feel bad. The pros struggle with selling too. Want to humble a $2-million-a-year fund manager? Ask about his sell strategy. He laughs nervously, swears he has one, then admits, half seriously, that every sell decision he's ever made is a bad one.

It's easy to understand why. The bull market for stocks that's endured since 1982 has elevated buy-and-hold from strategy to religion. We have no intention of rewriting this gospel, which we've preached for 25 years. In fact, we're still doing penance for the last time we strayed a bit. Our August 1997 "Sell Stock Now" cover story, in which we recommended reallocating 20% of your equity portfolio to less pricey areas, looked great last October, when the market dropped nearly 10%. Since then, of course, the Dow has surged to record highs.

Still, there are times when even the most devout buy-and-hold practitioner can't help thinking about selling. (Warren Buffett, whose preferred holding time is forever, was a net seller of stocks last year.) Perhaps a couple of your stocks have posted outsize gains and now represent a big chunk of your holdings. Maybe you're near a goal--college tuition, retirement, a second home--and you need to trim risk. Or you're wondering if this year's losers can rebound. Or you're just doing an annual, semiannual or monthly portfolio review.

Whatever your reason for pondering a sale, don't look at a stock's price and ask simply whether you should unload it. Instead, take time to pose questions and search for answers about the stock's prospects. To help you in your evaluation, we interviewed two dozen of the best fund managers around about their sell strategies--and how those disciplines might apply to individual investors who have a long-term focus. Alas, we didn't turn up any foolproof formulas. (There's a reason we didn't title this story "The Science of Selling.") But knowing the kinds of questions these pros ask themselves can help make you a more disciplined, and successful, investor, whether you end up being a seller or not. (For tips on evaluating your funds, see "Saying Good-Bye to a Fund," opposite.) We've constructed four familiar scenarios that are likely to prompt you to think about selling. A discussion of each follows.

MY STOCK IS UP BIG

Does it still offer me what it did a year ago? Is it too big a piece of my portfolio? This is the kind of sell dilemma we would all like to face and, happily, in this market, it may be the most common. That doesn't mean there's a one-size-fits-all answer. William Nygren, manager of $981 million Oakmark Select Fund, up 55% last year, says you should always have in mind a target price you feel reflects the potential you saw when you bought the stock. Some managers swear by these sell targets: They hit one and get out. But that often leaves money on the table, and individuals--remember--tend to cut loose their winners too quickly. Nygren sees the target "not so much as an absolute sell signal but as a benchmark when periodically re-evaluating your investment rationale." If earnings come in better than expected, he says, "or if similar companies sell for more than expected in the private market, raise your target."

Case in point: First USA. Nygren's employer, Harris Associates, bought the bank stock at its initial public offering price of $2.25 in 1992 (adjusted for splits). "Back then we had a sell target of $5," says Nygren, "but as the company continued to surpass our projections, we raised it." When Nygren started Oakmark Select in November 1996, he bought First USA at $28, with a target price of $45 to $50. A few months later, Banc One made a buy-out offer of $57 in stock, which lifted First USA's shares to $50. This time Oak-mark Select got out. Nygren liked First USA for its credit-card business and felt the $50 price reflected the franchise's value.

Another exit strategy comes from John Rogers, manager of the $198 million Ariel Growth Fund, who thinks the time to get out is when everyone else is getting in. "We rely on all sorts of benchmarks that individuals can use," says Rogers, a value investor whose small-company fund is up 17.2% annually since 1993. "If a stock starts showing up on a lot of brokerage firm buy lists, or if a lot of fund companies start owning it, or if the company gets mentioned a lot on television or in newspapers or magazines, we start selling." Example: tech school operator DeVry, which Rogers bought in 1991 at $2.50 a share (split adjusted) and sold in 1996 at $20. "We started seeing the stock in every other growth portfolio, and that scared us," says Rogers. Since then DeVry has risen nearly 70%, but Rogers says he has no regrets. "We made eight times our money," he says. "Sticking to our discipline is more important than being greedy."

If you have a stock that's gone up eight times over, it probably represents more of your holdings than prudence dictates. Charles Mayer, manager of $5.3 billion Invesco Industrial Income Fund (up 15.9% a year since 1993), says he never lets a stock amount to more than 3% of his portfolio. That translates into a minimum portfolio of 33 stocks. Most benefits of asset allocation can be gained with fewer than 20 stocks, and you likely don't have time to keep tabs on many more. So you may set a higher limit than 3%, but we suggest no higher than 10%.

That doesn't mean you dump a stock that's been great to you. Selling a winner isn't an all-or-nothing proposition. Growth manager John McStay employs a strategy familiar to anyone who plays blackjack. Say a stock has doubled or tripled and McStay still likes it, but he's worried that it may be too expensive. "We'll cut our position in half," says McStay, whose $175 million Brazos/JMIC Small Cap Growth Portfolio (recommended in "Small Wonders" on page 90) shot up 54.5% last year. "We've locked in a profit but can still benefit if the stock keeps rising. We're playing with house money."

Remember, though, that when you sell a winner, you're going to give up a big chunk of your gain in taxes (unless you're trading in a tax-deferred account). Here's the math: Assume your stake in Widget & Co. has doubled over three years, from $5,000 to $10,000. If you sell it and you're not in the bottom tax bracket, you'll owe capital-gains taxes of $1,000 (20% of your $5,000 gain) plus commissions. If you invest what's left in a new stock that you sell after three years, it must beat your old one by about 10% annually just to get you to where you would have been had you simply delayed the sale of the old stock. "We give a stock a haircut when we think about selling it," says Chris Davis, manager of $9.8 billion Davis New York Venture Fund, up 31.7% a year since 1995. "If we bought it at $20 and it's now at $100, then we think as if we're really selling it for $84 [$100 minus $16, or the 20% tax on $80 in capital gains]. If we'd buy it at that price, then we should not be selling it."

MY STOCK IS FALLING

Is it temporary? Should I buy more? Or is there a long-lasting problem? Odean's study suggests that the biggest mistake people make is hanging on to losers. But panic is an investor's enemy, and buying on dips--"averaging down" your purchase price--is a time-tested investing method. What do you do? Here are a couple of strategies to consider.

McStay generally sells a stock if it declines 20%. If the market is falling, he'll cut his losers more slack, but in a strong market, even a 10% decline may prompt him to bail. "We have learned," says McStay, "that our inclination is to make a mistake that we call 'macho analysis'--to tell ourselves that as soon as the rest of the world knows what we know, the stock will come back."

Because you, unlike most fund managers, don't have to chase short-term performance numbers, a rigid sell rule may not be a necessity. But be careful not to commit the sin of pride that McStay's dump rule is designed to avoid. That leads us to a second strategy: If a stock drops 15% or more in a flat to rising market, re-evaluate. Do you have real doubts about its long-term prospects? There's no easy answer, of course, but the recent tales of two stocks might be useful.

In 1996, $1.6 billion Third Avenue Value Fund began acquiring Applied Materials, the largest manufacturer of machines that make computer chips, for $12 a share. Last fall, the stock dropped from $54 to $17 (split adjusted) amid worries that Asia's economic woes would crimp profits. "The entire industry was down, so that made us look not just at Applied but at our reason for being in that business," says Curtis Jensen, a senior analyst for Third Avenue Value (up 18.7% a year since 1993). "We decided that demand for more and better chips would eventually reward the strongest companies." The fund hung on to Applied and put more money into other industry leaders. Applied recently traded at $34.

Now look at Nike. William Miller, manager of $4.7 billion Legg Mason Value Trust (up 18.8% a year since 1988), bought at around $15. Last year, the stock started falling from a record $76. Miller bailed at $60 in the summer, convinced that Nike had run its course. The stock hit $44 in March.

Let's compare the two companies. Both are leaders in their industries, but Applied Materials is in a business that's crucial to world economic growth. Nike is the leader--at up to $140 per pair of swooshes--in what approaches a luxury category.

Applied Materials has suffered along with competitors from a severe, but temporary, economic dis-location. Its leadership position isn't threatened. Nike is facing troubles when consumer spending is healthy, and its spot at the top of the shoe pile is challenged by changing tastes and by competitors stealing its marketing thunder. Given those differences, Applied's rebound and Nike's decline begin to make sense.

If you conclude that your loser isn't coming back, you can take some solace in the tax break that selling it will bring. Uncle Sam allows you to offset capital gains with investment losses in the same year and, if you don't have any gains, you can apply as much as $3,000 of losses against ordinary income or carry them forward for use in another year.

MY STOCK IS GOING NOWHERE

Should I be doing something better with my money? The question of how long to wait for a stock to soar is especially relevant to investors who don't always have cash to invest in their next big idea. "Often my decision to sell is prompted by a desire to buy something else," says Mariko Gordon, manager of the 18-month-old, $2.2 million Daruma Mid-Cap Value Fund. Gordon, who limits her portfolio to three dozen stocks, last summer dumped Chiquita Brands, at $15 a share, to make room for U S West Media Group, at $20. "I didn't hate Chiquita as much as I liked U S West," says Gordon, who learned the stock-picking business under veteran value investor Chuck Royce. "I thought it was a better use of capital." Recently, Chiquita traded for $13.75, U S West Media for $35.

Selling middling performers to make room for better ones drives the organizational structure at Brandywine Fund (up 20% a year since 1988), whose two dozen research analysts are divided into eight teams that vie for the fund's $9.5 billion asset base. In 1995, manager Foster Friess sold Brandywine's stake in General Nutrition, which had been trading in the $8-to-$16-per-share range for almost two years, to make room for Dell Computer at $4 (both split-adjusted). Since then, the vitamin retailer's stock has more than doubled--but Dell's shares have increased sixteenfold. You don't have eight teams of analysts, but you can still conduct an internal competition for your money. If you conclude you don't have a better idea, consider spreading the money tied up in your going-nowhere stock among your existing best ideas, if that won't overly concentrate your portfolio. Or just sit tight. An idea will come.

MY STOCK HAS DONE OKAY

But some of the fundamentals have changed. Which ones are noise, and which tell me something? Investors pay too much attention to news events that have little to do with a company's value, says Richard Howard, manager of $1 billion T. Rowe Price Capital Appreciation Fund (up 15.3% a year since 1993). In particular, he thinks the significance of political events and changes in company management tend to get overblown. Likewise, Howard says, investors wrongly concentrate on price-to-earnings ratios: "Prices are not fundamentals. They reflect fundamentals."

The key is to discriminate between meaningful developments and temporary distractions. Here are two fundamental shifts that you absolutely must heed: changes in a company's core business and (remember Nike) a falloff in its market position.

The former are especially common now, given corporate America's merger-and-acquisition binge. Has the company you're looking at, by acquisition or divestiture, changed its focus? In that case, it isn't really the stock you bought. In 1994, Ariel Growth's Rogers invested in Harte-Hankes, a diversified communications company. But this year he sold (after a better than 230% gain) because the company shed its TV and newspaper operations to focus on direct marketing. "Direct marketing is hot," explains Rogers, but "our reason for ownership is gone."

On the other side of M&A, digesting an acquisition can try a company and its shareholders. Mayer of Industrial Income looks for any signal that a recent purchase has dulled the acquirer's edge. He calls it the "cockroach approach--when you see one, there are always more in hiding." Mayer bought Union Pacific in 1995 at $44 "because it was the best-run railroad in the country. But after they bought Southern Pacific in 1996, we started hearing of problems with congestion and maintenance." He sold at about $64. The railroad recently indicated it would lose money for a second straight quarter and conceded it had no quick fix for integrating SP. The stock recently traded at $54.

Even a well-run company can see its franchise threatened, says Tom Marsico, once a top performer at Janus Funds who now runs two retail funds that bear his name. Take UAL. Marsico bought the airline at $44 in 1996. He stuck with it through labor unrest and saw it double. But increased competition for UAL's Asian business and that region's economic woes led Marsico to change his view. "We bought UAL originally because demand was exceeding capacity in its major markets," he says. Last fall the supply-demand equation changed, and he started selling at around $82. The stock recently hit $90 as oil prices plunged, but Marsico thinks he made the right long-term move. "When I buy stocks, I'm looking for ones that I never have to sell," he says. "But I'd be wrong to hold on just for the sake of holding on."