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 business 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 purpose 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:
Internal: dubious management behaviour, vague disclosure or complex accounting, aggressively increased merger activity, dizzying executive compensation packages.
External: intensifying new competition, disruptive technological onslaughts, deregulation, declining inventory and receivables turns.
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 investor
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 whether 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 market prices (
'emotional value').
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 (overpriced), many value investors follow the same mixed strategy adhered to when unsure whether a development is permanent or temporary:
SELLING SOME, BUT NOT ALL.
Main Points:
Many financial experts advise the selling of part of the stock. The rest is left to grow further. In this way you get part of your profits and let the rest generate further returns.
Don't sell just because the price has gone up or down, but give it some serious thought if one of the following things has happened.
- Did you make a mistake buying it in the first place?
- Have the fundamentals deteriorated?
- Has the stock risen too far above its intrinsic value?
- Is there something better you can do with the money, that is, you can find better opportunities?
- Do you have too much money in one stock, taking up too much space in your portfolio?
In a portfolio of good quality stocks bought at fair or bargain price, there are usually few reasons for selling. However, the businesses of these companies need to be tracked regularly and their quarterly results announcements followed.
When should a stock be sold?
Firstly, if the fundamentals of the stock are deteriorating, the stock should be sold urgently.
Another good reason would be when the stock is overpriced.
- Be alert when the PE of the stock has risen by more than 50%above its usual average PE.
- Reappraise the fundamentals and valuations of this stock, in particular, its future earnings growth potential.
It maybe timely to cash out on a portion or all of a stock if
- the present high PE cannot be justified or
- if the present high PE has run ahead of the fundamentalsof the stock.
Related:
Taking Profit and Reducing Serious Loss
