This is a very tricky question that always confuses investors. Most of the investors do not know when exactly to sell their shares because after they sell the share price increases, which leads them to confusion, as if they have made a wrong decision. Often, regretful.
As a context, to sell away a stock, you have to think from your entire portfolio point of view. The idea of building a portfolio is exactly like building a basketball team. If you have Michael Jordan who is able to help you to win tournaments after tournaments, do you want to sell him away to other teams?
Probably not, but interestingly in the stock market, most people would. When they have seen one of their stocks appreciated 20% in share price, they would happily sell it away. On the flip side, for those stocks that declined 50% and more, they will hold them and “hope” the share prices will relive its glorious days. Even most of the time, when there is no hope, they will still hold it in denial.
Stock market has been proven to be one of the best wealth creation paths. But ironically, most of the investors are not able to compound their wealth over the long run in the stock market. Why is that? Most of the time its due to lack of knowledge and emotional stability. Imagine, you have invested into companies like Nestle, Nike and Hartalega 10 years ago, and you sold your shares when the share price increases by 20%, then you will miss out few hundred percent or few baggers of gain. Because you are selling away your Michael Jordan away!
But, don’t get me wrong. I am not saying that successful investors do not sell away theirs shares, because even Warren Buffett does sell shares away. What I am saying is that, value investors do sell shares based on some criteria, but definitely not because of the increase of share price. In this week’s article, we will share with you 3 criteria when value investors will sell their shares away.
1. Reason for Buying No Longer Valid
When you invest in a stock, you must have reasons to justify. Sometimes, the reasons could be the company has high growth prospect, or a cash cow business which pays a lot of dividends or even a potential turnaround by the new management. They are all solid reasons to justify your investment decisions. However, there are still things that you can’t control nor predict. As time goes by, business will evolve and face different kind of challenges.
There are times when your initial reason of buying of a company it’s because it has high growth potential in overseas market, but it turns out otherwise. Perhaps, overseas expansion failed as the products are not welcomed and growth slows down. Or maybe you thought that the new management team is capable enough to turn the company around, but in the end they couldn’t. Or initially it is a great business with strong competitive advantage, but as time goes by, the business is no longer able to innovate further and begins to lose market share. Whichever the case, when the reason for buying is no longer valid, you should sell your shares away, even if it is at a loss, and move on.
2. Found a better opportunity
As a value investor, you must always ensure that you invest in low risks company with the highest potential return. When you have discovered another company which has better prospect, lower risks and a better bargain in share price as compared to your current one, then you should sell away and invest in the better one.
There are tens of thousands of stocks around the world. It is impossible to understand all of them at a time. It takes time to discover and unearth great companies. Stock idea will emerge if you constantly look out for it. When it comes, you just have to compare and see if it is a better one. If it is, then you should sell away your current stock to invest in it, even at a loss. It is always a good reason to sell away your stock to invest in another stock with better prospects.
3. Portfolio Rebalancing
When you invest, you must always look from the entire portfolio point of view. One of the best reasons to sell is when one of your stocks appreciates and outweigh the others. If one of your stocks is more than 15% of your total portfolio, then you should consider trimming it down no matter how promising the prospect could be. By limiting the maximum exposure for each individual stock, then you will be able to manage your portfolio in a smarter way.
It is very important to have a well-balanced portfolio because there are things that you can’t control, for example how much the market is willing to pay for your stock and how long will the business stay strong. Thus, you must only work on the things that you can control, which is to properly allocate your money into 8 to 10 stocks. When you have such balanced portfolio, your downside is limited but your upside is unlimited.
Value investors do not sell based on the share price fluctuations because share price movements do not give any useful information about the business. It only suggests whether the market is optimistic or pessimistic as it will move in all sorts of direction in the short term. But in the long term, the share price performance will be based on the earnings and cashflow of the business. So, if you sell shares based on short term share price movements, most likely you will not do well in the long term.
One of the biggest myths in investing in stocks is you will never make money not selling away your shares. But if you look at the wealthiest people in the world, they are either entrepreneur or value investors. They do not get rich by selling away their shares, they get rich by holding their shares because they understand the power of compounding. The key to winning in the stock market is like winning in the basketball tournament. You have to build a strong portfolio (basketball team) by holding your winners (great players) and selling your losers (weak players), let compounding work in your favor, but not the other way around.
Disclaimer: All facts and opinions presented are for educational purposes only. This is not a recommendation to buy or to sell. The author involved in the writing of this message has no vested interest in the companies. Please consult a professional for expert financial or other assistance or legal advice.
This article was written by Team VIC
Team VIC is formed by experienced and well-trained individuals from Value Investing College (VIC). The team has been consistently studying the latest stocks market trend in order to focus on educating the layman on investment principles and techniques.