Wednesday, 24 June 2009

Why we sell? Because of the fundamentals

When you're building your portfolio, then, you want to pick the stocks that have the best fundamentals - because (sorry again) over the long run, investors gravitate toward stocks with strong fundamentals because they are the strongest companies.

If the stock's fundamentals have slipped, however, so that it no longer meets the criteria you used to buy it, it's time to sell and replace it with another stock that does meet your criteria(and one that thereby has better prospects of rising in value).

Your selling is based on ongoing re-evaluation of portfolio at regular intervals

The selling assessment is thus an ongoing re-evaluation of where a stock stands right now. You must continually reassess what the stock's prospects are going forward - not what they were a month ago, six months ago, or whenever you bought it.

On average, using monthly rebalancing period produce the highest raw return.

The important point here, whether you use a one-month rebalancing or a different time frame that works for you, is this - you need to re-examine your portfolio at set intervals, to assess how your holdings stand relative to the reasons you bought them. If they no longer meet the criteria you used to pick them, you should consider replacing them with new stocks that do make the grade.

By sticking to a firm rebalancing and reweighting plan, you keep emotion and hype from impacting your selling decisions. You sell at regular intervals, and you sell based on fundamentals. Just as with buying stocks, there's no place for hunch-playing or knee-jerk reactions here.

Price matters in how it is related to fundamentals

Whether the stock price has dropped sharply since you bought it or whether it has skyrocketed is no matter; what matters is where the stock's fundamentals stand right now.

Price - just as with buying - matters only in terms of how it relates to the fundamentals (what the stock's PE or P/S ratios are, for example).

Many investors will sell a stock:

  • because its price has fallen and they think they need to cut their losses, or
  • because the price has risen and they think the "smart" thing to do is to take the profits rather than risk the stock coming back down.

But those are arbitrary, emotional decisions.

When stock should be sold immediately

There are a couple rare occasions, however, when you should sell a stock without waiting for the rebalancing date to arrive.

  • If a firm is involved or allegedly involved in a major accounting or earnings scandal, you should sell the stock immediately, because you can no longer trust its publicly disclosed financial data.
  • In addition, if a firm has become a serious bankruptcy risk since the last rebalancing, you should also sell its stock immediately.
So with all of these challenges, how do you stave off emotion and make good, sensible "sell" decisions? The same way that you keep emotion at bay when deciding what stocks to buy: By using a disciplined system that makes sell decisions based on cold, hard fundamentals - not emotion-driven hunches, or arbitrary price targets.

Making good sell decisions is another reason for better returns in your investment portfolio.

Related posts:
Why we buy? Because of the fundamentals
Why we hold? Because of the fundamentals
Why we sell? Because of the fundamentals
Always buy, hold or sell based on fundamentals.

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