A vexing question facing investors during market sell-offs is whether to join the pack. For value investors, the answer is no, but the more pertinent question is when to sell.
Value investors set selling criteria at the time of purchase. Their attitude in buying is to select stocks that are least likely ever to trigger the criteria for selling.
But businesses change, and when they deteriorate, their shares should be sold, just as the owner of a business sometimes must decide to close down. When selecting stocks, value investors specify what deterioration means for purposes of selling. The logic is simple: The same factors used to select and avoid stocks are used to decide which stocks to sell and when.
Sales are indicated when the key factors supporting an original buy are gone. Here is a summary of such factors:
(1) Internal:
- dubious management behaviour,
- vague disclosure or complex accounting,
- aggressively increased merger activity,
- dizzying executive compensation packages.
(2) External:
- intensifying new competition,
- disruptive technological onslaughts,
- deregulation,
- declining inventory and
- receivables turns.
(3) Economic:
- shrunken profit margins;
- declining returns on equity,
- assets, and investment;
- earnings erosion;
- debt increased aggressively in relation to equity;
- deterioration in current and quick ratios.
Value investors avoid selling when bad news is temporary. Single-quarter profit margin slippage should provoke questions, but not sales orders. If investigation shows deeper problems, then the condition might be permanent and selling indicated. Permanent deterioration requires more evidence.
When in doubt concerning where deterioration is temporary or permanent, value investing might include a hedging strategy. This would call for selling some but less than all shares held.
Value investors never sell solely due to falling prices. They require some evidence related to the declining intrinsic value of the business to warrant a revision in the hold-or-sell calculus. Stock price fluctuations are far too fickle to influence such an important decision.
In the case of a preset policy to sell when price reaches a certain high level, many value investors follow the same mixed strategy adhered to when unsure whether a development is permanent or temporary: selling some, but not all.
Also read:
- Stock Market Prices
- Market metrics P/E and Intrinsic value
- Rational Thinking about Irrational Pricing
- The Anxiety of Selling
- Control Value of Majority Interest
The Anxiety of Selling
Summary: A Disciplined Approach to Selling
For value investors, the decision to sell is not driven by market panic but by a pre-defined, disciplined process focused on the company's intrinsic value, not its stock price.
The Core Principle:
Selling criteria are established at the time of purchase. The goal is to buy businesses so strong that you are unlikely to ever need to sell. A sale is only triggered by a permanent deterioration in the very factors that made the company a good investment in the first place.
Key Reasons to Sell:
Deterioration is categorized into three areas:
Internal Issues: Poor management behavior, unclear financial reporting, aggressive acquisitions, or excessive executive pay.
External Threats: New competition, disruptive technology, or regulatory changes that harm the business model.
Economic Decline: Shrinking profit margins, falling returns on equity and assets, declining earnings, or a worrying increase in debt.
What Does NOT Trigger a Sale:
A falling share price alone is never a reason to sell.
Temporary bad news should prompt investigation, not an immediate sale.
Practical Strategies for Uncertainty:
The Hedge: If you are unsure whether a problem is temporary or permanent, a common strategy is to sell only a portion of your holding.
Taking Profits: The same "sell some, not all" approach can be used when a stock reaches a high price target, allowing you to lock in gains while keeping a stake for future growth.
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