Imagine yourself as an investor holding shares in ABC company at an average price of $10, which you have bought at a reasonably fair price based on your conviction. You see the stock price slide downwards to $9.50 in the short term and you managed to convince yourself that you are a long term investor. A couple of months later, the stock price trend upwards (and above the entry price) to $11. You pulled out your spreadsheet and a 10% gain is staring right in front of you. You hesitate a while and look out for news around to see the outlook of the economy. Heck, there is going to be some projected problems in the next few months ahead, let me lock in the gains first, keep them in my watchlist and re-enter them again when the price has gone down lower.
This post is about finding out the beast-art of selling stocks and the right convictions or reasons to selling. This is not a debate about whether you have made the right choice to sell because this can only be proven on hindsight and there is no way anyone can tell you it's right or wrong to do so unless things have happened.
A lot of books and value investing courses are focused on the art of buying but seldom do you see anyone touches on the action on selling. To me, I am not delusional to only buying. As an investor, I believe that we act as a business owner and every business has a valuation where there will be a point where the price is attractive enough to sell. It does not matter whether our term of valuation is subjective as long as our conviction to selling has led to the right justification to it.
Yesterday, I casually posted a question to one of my circle of close financial bloggers friends in the chatgroup. I just wanted to see the perception of what the majority of investors are thinking. I posted a question to see which of the following is the hardest as an investor:
1.) Entering into a position when everyone is selling and there's blood on the street.
2.) Building up a core position based on conviction within a portfolio.
3.) Sitting on a fundamentally unchanged business fundamentals and seeing a rising share price.
Majority of the choices led to choice number 3 because the temptation to take profits is there, akin to putting a gambler who has promised to quit gambling in front of the gambling table and do nothing. There's a reason why many investors sold their winners too early while holding on to the losers too long.
The recent market surge has provided a very good opporunity for investors to exit positions at a gains to lock in profits. I've written about the "half-half philosophy" in my previous post (here) to substantiate this point. The decision to sell should ultimately be wrapped upon your end goals, not for short term gains. This is the reason why we need to have a clear investment thesis when buying and that is to ensure that we do not engage in emotional trading in the short term. Sell only when these investment thesis are broken, either because the fundamentals are weakening or valuations are too high.
I am taking the below graph from my good fellow blogger, Jason (who blogged here) who illustrate this point. This is not to point out that divesting shares at a 20% or whatever it is is not fantastic, but to have a clear investment thesis and effective investing strategy because you never know if the fundamentally great stock you are selling will ever go back to a price lower than what you are selling at. If so, are you saying that you forego a fundamentally great business and start to look on for a new business with the same level of fundamentals but undervalued? A wonderful business with strong economic moat is usually very rare to come by, so I wouldn't be sure if I am willing to divest that for a mere 20% profits or so. Think yourself as a business owner and you get a better picture.
I've been a victim more than once now caught in this situation when I sell a fundamentally good stock in Boustead at a sub-par of $1+ and it has gone up ever since. This is not to say that it won't go back to where it was but the chances are highly unlikely unless the fundamentals dropped massively or the economy is tanking because of severe depression. Even so, my investment thesis for the stock would have changed too.
I've been thinking of coming up with an informal sort of questionnaire for myself whenever I contemplate to sell something. This may not be comprehensive but I think these 10 questions allow us as investors to think through the whole end to end processes from buying to selling.
1.) What is the rationale behind the reason to sell?
2.) Are the fundamentals weakening? Has the fundamentals changed?
3.) Are the valuations too high compared to peers or historical average?
4.) Would I be a buyer at current price?
5.) Are there better alternative investments I can allocate the capital to?
6.) Was it driven by fear of the market/economy/news?
7.) Are the companies exposed to product or market cycle upturn and downturn?
8.) Are the companies still responding to positive catalyst news?
9.) Are the companies or management doing share buyback?
10.) Am I selling (not selling) because my average entry price is low (high)?
Just like buying, the decision to sell is ultimately personal.
As long as we've think it through and the decision doesn't get emotional, we should be able to make a more rationale decision than we would have if otherwise.
As you might probably realized by now, our behaviors and decisions drive whether we ultimately end up with a great investments or not. We'll be far more successful investing in stocks generating average returns than we will with the highest potential returns but with bad investing habits and behaviors.
What do you think? Do you agree or disagree? Which of the 3 choices you think would have been the hardest for you as an investor?