As deep value investors, we invest a lot of time and brainpower into deriving the fair value of a company. We first figure out our preferred investment strategy and find companies that fit the criteria. However, buying has always been the easy bit. When should we actually be selling a stock?
Selling a stock is made especially difficult if you have big unrealized losses on the stock. Imagine your stock being down 50%, one’s mindset would be to just hold it and wait for it to recover.
Before we dive into when a value investor should be selling, we will share with you when a value investor should not be selling.
1) “The market is tanking, I should sell before it gets too late!”
Halt! Stop for a moment and recall the reason why you bought this stock in the first place. Was it for you to unload it when the price falls or to generate a crazy amount of returns in the next 5 years? It is a universal fact that the stock market operates in a cycle and while there are up times, there will be down times. By succumbing to the psychological pressure emanating from the stock market, coined as Mr. Market by Benjamin Graham, you are giving in to fear and letting go of any extraordinary gains you might make in future. Ultimately, we have to go back to our initial investment thesis and ask ourselves did it change? Is the fall in the market just general fear in the market due to some news?
2) “Alright, I will sell and repurchase when the market bottoms out or when it is recovering.”
Many investors in the market claim that they have the unique foresight to time the market but how much of it is true?
Humans have a natural tendency to observe patterns even when there are none to begin with. The movement of prices in the short run is motivated by random news events and noises all over the market – an attempt to time the market is futile. In the words of Benjamin Graham, “In the short run, the stock market is a voting machine… But in the long run, the market is like a weighing machine.”
3) “Wow, company ABC has rallied 40%, I should quickly take a profit.”
Once again, recall the reason for purchasing this company in the first place. If your due diligence shows that the company’s fair value is much higher, and remains undervalued after accounting for a margin of safety, then why are you should you be swayed by the sudden surge in prices?
Now that you are aware of the potential pitfalls, you are ready to know when you should be selling a stock.
Good reasons for selling a stock:
1) When it fulfils your selling condition.
There can be many ways around this but as a deep value investor, we are frequently concerned with our reference value – the intrinsic value. As the price approaches our intrinsic value, it may be wise to start selling the stock. Any further upside you may potentially receive will be less certain than any new ideas you may have for the capital.
Out of the ten, twenty companies you have picked, mistakes are bound to be made. Even the legendary investor, Warren Buffett, has made a fair share during his time. However, if you stick to this tried and tested value investing approach, your “winners” will overshadow your “losers”. Dealing with mistakes is a whole lot more complicated than in theory. To recognize a mistake, we must first admit that we have made one, and this seems to be an extremely challenging task for our egos.
In short, constantly question your investment thesis, recognize your mistakes fast, cut losses, learn and move on.
Note: Short- to mid-term movement in share prices does not necessarily suggest the skills of the investors. We have to constantly evaluate the driving force behind the movement.
- Dynamics of the company has changed drastically. This can occur due to the many risks of investing in businesses. You may be absolutely right when you have first purchased the company but by a stroke of bad luck, the management may become complacent and steer off-course. If these circumstances arises, we urge you to sell immediately and look for alternatives to employ your capital.
- Better opportunities. The world is your oyster. We will constantly be finding new stocks and if one presents itself to offer a much better risk reward ratio then your current stocks and a higher probability for the upside potential, it would make sense to sell off one with a lower probability.
Transacting in a stock market is fraught with numerous pitfalls. The best precaution you can take before embarking on your investing journey is to be well-equipped and well-prepared by constant learning. Once you have started investing, follow your portfolio closely and be an expert on the companies you own. Never succumb to complacency and let some few wins ever get into your head!