When to sell your shares?

The value investor makes profit when he buys, not when he sells. His skill lies in identifying mis-priced stocks, and holding them for a long period of tie. Of course, the cash comes in only when you sell it, till stocks are sold it is only notional profits. Your stock may rise from Rs 100 to Rs 1000 before diving down to Rs 50. In the ultimate analysis it is the cash that comes in that matters, not the price history during your period of holding. But if you have invested in a company that keeps growing every year at a high rate of growth you don’t have to sell it at all, and may remain invested till you need to liquidate your portfolio, or till you want cash. A lot depends upon which version of value investing you are following. If you are an investor like Benjamin Graham, and are looking for a bargain in terms of breakup value, without any consideration to the future profitability of the company, then you would sell the shares as soon as the price rises to meet the value curve, and no value if left in terms of current market price. However, if you are someone like Philip Fisher, or Warren Buffett or Peter Lynch, you may not sell your shares ever, unless there is a fundamental problem in the company.

Buying is an easy decision, find a margin of safety and buy it. Selling is a tough job, sell early and repent for the loss of future profits, don’t sell it when the price is high and you may be forced to sell it later at a lower price. You may not find much guidance on selling in the financial literature. I am attempting here the rules that an investor can follow successfully. It is important that the investor is aware of the criteria that would lead him to sell his shares right from the time he buys his investment. This is utmost important. If he decides to sell as he drives on the highway, his decision is likely to be influenced by frenzy, and impulse, and he may end up leaving money on the table as he exits his investment.

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Let us understand various situations.

 

Remember why you bought it in the first place

If you bought a stock just because it was a bargain at the current market price, without bothering about the credentials or the long term sustainability of the company, it makes sense to sell it off the day the target price is reached. The margin of safety has shrunk to zero at that point, and there is no juice left in the company. Liquidity in the market may push the price higher but that would mean riding on the momentum. There is no harm in riding on the momentum also after the price line meets the value line, but must do that with caution. As the price moves up, you may keep upping your stop loss limit. You can actually put your stock to an autopilot mode now, as the price goes up, up the stop loss limits, and enjoy the ride. If there is a sharp sudden fall, the autopilot mode would trigger an auto sell off from your account. Note that in the normal course, this option is to be discouraged; speculators ride the trends not the investors reading this book. However, we make an exception, only in respect of investment that has ‘matured’.

If you had bought a share as a growth stock, a company that has grown at 20% p.a. for the past 10 years, and you discover that in the changed business environment, the rate of growth is not achievable, and the fundamental assumption is no longer valid, that certainly is a valid reason to sell of the stock.

If a new technology has suddenly disrupted the business practice, and your company may not have wherewithals to change to the new technology, it could invoke a sell call.

 

Portfolio re-balancing

Some people like to re-balance their portfolio when the share of one of the investment rises beyond a predetermined limit. We recommend owning not more than 20 scrips at any point in time. In order to keep it simple to understand, let us assume you invested in all your scrips in one go, and your total investment is Rs 20 lakhs. Going by our recommendations, you bought 20 different scrips, each amounting to Rs 1 lakh. Lady luck smiled on you and one of your scripts rose 20 times ( to explain the concept I presume the value of other scrips remains same), and thus your portfolio now looks like this:

Total number of scrips      20

Purchase price              Rs 20 lakhs

Present market value        Rs. 39 lakhs ( 19 lakhs unchanged, one scrip at Rs 20 lakhs)

 

As you can see the share of this scrip in the cake is now almost half ( 20 lakhs / 39 lakhs). If this share were to fall 10% next week, your total portfolio would be affected by 10%. This makes your portfolio grossly skewed. Some people set an automatic trigger to alert them when particular scrip in the portfolio rises to, say beyond 10% of total portfolio.

Should you be doing that? It is a matter of individual choice, and again a lot depends upon the fundamental assumptions your investment is based on. While re-balancing your portfolio makes it less risky, it is quite likely you are cutting off the branch that gives the maximum fruits. You might sell a growth and end up buying a sluggish investment.

My personal strategy is to allocate capital to my portfolio in a way that there is a fair allocation to each of the scrip (Not calculating exact 5% in exact figures). When some stocks rise to make the allocation unbalanced, such as in the example given above, I DO NOT rebalance the portfolio. If a company is growing I must continue to ride on the growth. This seems to be the best strategy to follow. Sometimes you may find that the prise rose not because of a fundamental reason but because of mindless speculation, and the present price is crazy compared to valuation, you may quit the investment altogether and go back home with wads of cash. As a cautious value investor who believes less activity in market always wins in the log run, I would not do that also. For me it is just buy and hold.

 

Better investment opportunity

There is a limit to fresh money that you can bring in to the market. If you come across an opportunity too attractive to ignore, you might think of selling off some of the old stocks and use that money to acquire the new investment. This becomes important who do not have regular cash flows and usually remain fully invested. To reiterate, you are likely to make more money in in-activity rather than in activity. If you are not likely to have future cash flows, it is all the more important that you invest in the right scrip in the first place, and stay invested in it for as long as you can.

Berkshire Hathaway has a different approach to handling the opportunities that suddenly emerge. They sit on a large cash balance, which remains uninvested till a suitable investment is discovered. You may not afford to have the luxury of sitting on a pile of cash, so this option is ruled out for most people. A better thing is to plan for an income stream that gives periodic return which could then find its way to the stock investment.

 

Weeding out the stocks that failed to grow

A value investor has unlimited patience, as long as he is certain of the fundamentals of his investment, he waits with patience. However, it may so happen that one or two scrips out of his portfolio tun out to be weeds. The fundamental assumption was wrong, or got changed on the way, or that the company misrepresented facts, and so on. It may be periodically appropriate to sell off those stocks, and carry a clean growing portfolio. If fundamentals have gone wrong, and the value of an investment has eroded, it is an exercise in futility to wait for the price to rise so that you recover your capital. The human minds hates to see loss, and would often wait for the red to turn green before he squares up his account. This might mean waiting indefinitely. The suggested course is to know and realise that there is a permanent impairment of your investment, sell it off and invest your money in another, better security. I prefer to examine my portfolio once every year to see the possibility of any weeds developing.

Why should you not worry too much about booking losses? Stock market is skewed unfairly in favour of the investor. If you have invested Rs 10,000 in a stock, theoretically you might lose all Rs 10,000 if th investment goes bad, though this will seldom be the case. But when your investment rises, it may soar high in the sky, 10 beggars and 20 beggars and even beyond is not uncommon. Your Rs 10,000 may turn into Rs 1 lakh or even beyond. There is a story about how Warren Buffett was riding an elevator up to his office and on the floor was a penny. He was not alone, there were several executives in the lift as well, but none took notice of the shiny penny. When the doors of the elevator opened, Buffett leaned over and picked up the penny to the shock of the executives. As he left, without turning around he held the penny up over his shoulder and said “The beginning of the next billion.” I am not sure if the story is true or not, but it does give an important lesson about the infinite potentials of stock market investment.

 

Selling when you have met your investment goals

This is perhaps the happiest feeling. Your goal was to retire at age 55 with a capital of Rs 10 crores, and you have achieved the target. Or you had certain goals like your daughter’s education, buying a farm house, travelling the world and so on, and as your investment grows you do a planned withdrawal as the requirement of funds comes. If you have a big capital outflow planned say three years from now, it becomes prudent to sell off at least partly, so that you average out the fluctuations. Withdrawing at the exact moment of such event may make you precarious to volatile market forces.

 

 Selling when you need cash

Lastly, some emergency may pop up, some contingencies may arise, where you do not have other resources to draw from. Your investment may have to be liquidated at that time. In the present smooth electronic trading system, you get the money into your account in 2-3 days. Money is available when you want it. Philip Fisher, the legendary ‘buy and hold’ investor would never sell his holdings, and one main reason he would give for selling the holdings was this: when you need money.

 

 

©Dr. Tejinder Singh Rawal

Chartered Accountant

M. Com, MA (Economics), MA (Public Administration), MA (Urdu), LLB, FCA, ISA, CISA, CISM, PhD

This content is copyrighted and no part of it may be reproduced without the consent of the author

 This discussion will be a part of the forthcoming book by me “The Smart Long Term Investor: Common Sense Strategies for Wealth Creation” Suggestions are welcome and will be appreciated

 

 

 

 

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