During the past few weeks I have interacted with a number of my readers and one common question was, I have so and so shares in my portfolio, the sensex is close to 18000 should I sell my shares?
The “Sell” decision is the most difficult decision in stock markets. Even the professionals get it wrong. Otherwise mutual funds would not have negative NAVs and returns. It is always easier to buy a stock then to sell it. What if you sell and the share price climbs further in the next few months. Then you are left looking like a fool. And if the share price goes down, you feel you were such a wise guy who knows the markets completely.
Apart from the financial aspect, the behavioural and emotional aspect also starts playing a role. People develop an emotional bond with the stocks they own and they are unwilling to let go of those stocks. Secondly, if they sell at a loss, their ego takes a hit. The seller has to accept that he or she was incompetent or stupid to buy that stock and not many of us are willing to accept that.
I have also made numerous mistakes in my sell calls. Either I sold them prematurely, or I did not sell them when I should have. Therefore, it is a must to have a standard system for deciding when to sell.
A lot of analysts give various reasons for selling a stock. After studying a lot of them and out of own experience I have found that the best method to sell is by following Pat Dorsey. Pat Dorsey was the Director of Equity Research at MorningStar Mutual Fund. Dorsey’s four point simple procedure should be your mantra to sell:-
1. Sell if you made a mistake.
2. Sell if the fundamentals of the company have changed for the worse permanently.
3. Sell if your share is overvalued and at a price which is not in line with the fundamental growth of the company, eg Infosys in 1999 was at Rs10,000 per share. No reason for any investor to hold on to it. Midcap and Small Cap IT companies like DSQ Software were quoting at a PE multiple of 60. Similarly, in the 2007-2008 period almost all stocks were priced way beyond their fundamental earnings and profitability.
4. Sell to buy something cheaper. Today shares of Nestle are trading at a PE multiple of 40. The growth in stock price may still occur but one may find cheaper bargains with similar or better growth prospects, so I may want to sell Nestle and buy some other stock.
There needs to be no other reason for a stock picker to sell.
To quote a comment of a fundamental value investor, “I have one general rule for anyone who’s just beginning to invest. If you don’t believe that you’ll have the time, interest, inclination and most importantly the patience to spend on research, education and due diligence in regards to investing, either use a good fee based adviser or use index funds and let them ride. Statistically, a majority of investors get far too involved emotionally and as a result under-perform the market over long periods of time. Basing investment decisions on media outlets, talking heads, etc. will likely empower you to join the herd that normally follows the hottest trend. As a result investing becomes like speculation and pure gambling instead of what it’s intended to be.” QED.
If one finds that the reason for his or her selling are consistently serial 1 and 2 above, then one needs to question his ability to pick stocks and one may be better off investing in real estate or mutual funds. Stick to Index based ETFs and you are likely to sleep soundly without worrying and still be able to capture the growth of the whole economy or markets with market based returns. And just a reminder, switch off all the TV channels and financial advice spewed out 24/7. That’s plain noise.
Sir, not related to the article, but can you guide how do you pick companies i.e. how to start off. Like do you analyze each and every listed coy or at random or is there some logic as to how to pick companies before you analyze and short list them. Request if you could guide with the method, how can I learn to initially choose a company for analysis of the business.
Thank you.
Dear Mihir,
I am sorry I was out of country and was just vacating so did not feel like writing.
You have asked a fantastic question. I am answering through a post.
Sir, should one also sell if he has bought something which he doesn’t understand.. yours thoughts please..
Anshul gaur
I would sell. Remember there is something called a circle of competence. Remain within it. The stock markets have all kinds of companies. I used to invest earlier in anything and everything. Later on I realised it was better to pick about forty or fifty companies or businesses which I could understand and invest only in those at a right price.