Reasons to Sell
Provided that a share of stock is bought at a reasonable price, there are only a few reasons to sell it.
1. An Analytical Mistake Was Made
If upon buying shares, you later conclude that errors were committed in the analysis – errors which fundamentally affect the business as a suitable investment – then you should sell even if it means a loss will be incurred. The key to successful investing is to rely on your data and analysis instead of Mr. Market’s emotional mood swings. If that analysis was flawed for one reason or another, move on. Sure the stock price can go up even after you sell, causing you to second guess yourself, but the key to successful investing is to learn from mistakes. Everyone will make mistakes. Learning from a mistake that costs you a 10% loss on your investment could ultimately be one of the best investments you make – if you learn from it and go on to make better investment choices.
Of course, not all analytical mistakes are equal. For example, if a business fails to meet short term earnings forecasts and the stock price goes down, that’s not necessarily reason to sell if the soundness of the business stills remains intact. On the other hand, if you see the company losing market share to competitors that could be a sign of long-term weakness and likely a reason to sell.
2. Rapid Price Appreciation
It’s very possible that upon buying shares, the stock price, for one reason or another, rises dramatically in a short period of time. The best investors are the most humble investors. Don’t take such a quick rise as affirmation that you are smarter than the overall market. Indeed, one’s chances of making money in the stock market over the long run increases significantly if you buy cheaply. But a cheap stock can become an expensive stock in a very short period of time for a host of reasons, some of which are likely due to speculation by others. Take your gains and move on. Even better, should the shares decline later, you may be presented with the opportunity to buy again. If the shares continue to increase, take comfort in the old saying, “no one goes broke booking a profit.”
3. Valuation is No Longer Justified by the Price
This is the most difficult reason to sell because valuation is part art and part science. The value of any share of stock ultimately rests on the present value of the company’s future cash flows. Valuation will always carry a degree of imprecision because anything in the future is uncertain. Hence this is why value investors rely heavily on the concept of the margin of safety concept in investing.
A good rule of thumb, although by no means mandatory, is to consider selling if the company’s valuation becomes significantly higher than its peers. Of course, this is a rule with many exceptions. For example, just because AP and Mobil Company trades for 15 times earnings while Dangote Sugar trades for 13 is no reason to sell Nestle, especially when you consider dominance with which AP products command.
Another more reasonable selling tool is to sell when a company’s P/E ratio significantly exceeds its average P/E ratio over the past five or 10 years. For instance at the height of the Internet boom, AP shares had a P/E of 60 times earnings. Despite AP’s quality, any owner of shares should have sold and potential buyers should have looked elsewhere.
The Bottom Line
In summary, any sale that results in a gain is a good sale. When a sale results in a loss, and is accompanied by an understanding of why that loss occurred, it too may be considered a good sell. Selling is bad when it is dictated by emotion instead of data and analysis. Remember not to judge your selling by whether or not you are selling at the top. Instead focus on selling for reasons dictated by rational reasons of valuations and price.
