Investing successfully is not just about picking the right stocks.
You also need to make informed buy and sell decisions on the stocks you choose, which ultimately impacts your overall investment performance.
These decisions are crucial for maintaining a robust portfolio and should be an integral part of your investment strategy.
Here’s what you may miss: buying a stock is the easy part.
After conducting your due diligence, you can purchase the stock with just a click.
Selling, however, is more complicated.
Your decision is hindered by emotional factors like greed and fear.
If you’re thinking about making a sale, take a moment to reflect on these scenarios before making your move.
The joy of booking a profit
Selling a stock is never straightforward.
When you buy shares and its price rises, you have an unrealised profit.
Some investors don’t consider this “paper profit” as real until they actually sell the shares.
Unrealised profits can feel fleeting as it might disappear if the stock price suddenly drops.
Often, the driving force behind the decision to sell is greed.
Eager investors looking to realise their profits are too quick to sell, but they rarely stop to consider whether they might be giving up significant gains in the future by cashing out too early.
A great example is DBS Group (SGX: D05), Singapore’s largest bank.
In March 2020, when the pandemic hit, its share price fell to as low as S$15.35.
A year later, the stock price rose to S$25.64.
Hence, selling DBS at this level will net you a solid gain of about 67 per cent.
Cashing out for a 67 per cent profit feels like a victory, it means you’d be missing out on even bigger gains.
Today, DBS shares are hovering at around S$39.
Hence, you missed out on a further 52 per cent gain.
In fact, if you had held on, you would have more than doubled your investment in DBS. This return doesn’t account for the three and a half years of dividends you’d have missed if you sold in March 2021.
This example highlights the pitfalls of selling shares too early.
The key is to stay focused on the company’s growth potential.
If it has catalysts that can boost revenue, profits, and cash flow, you’ll do better in holding onto your shares.
The future capital gains you could achieve by holding on will likely far exceed the small profit you realise from selling too soon.
Finding a stock that doubles is not easy.
So if you found a great business, be ready to hold it.
Another great example is Fortinet (NASDAQ: FTNT), a standout growth stock in the cybersecurity sector.
Over the past five years, Fortinet’s stock has surged by an impressive 400 per cent..
Furthermore, the management has identified a total addressable market of US$183 billion in 2024, which is expected to grow at 12 per cent annually, reaching US$284 billion by 2028.
With projected annual revenue of nearly US$5.6 billion for 2024, this promising sector offers numerous opportunities for further growth.
In other words, if you had sold Fortinet any time during the past five years, you would have missed out on significant wealth-building potential.
Don’t let fear overcome you
Greed is not the only factor.
Some investors may sell stocks out of fear.
Simply said, when stock prices fall, fear can take over.
In such moments, panicky investors hastily sell their shares to avoid further losses.
This reaction is driven by fear.
Selling in a panic can inadvertently lock in large losses.
It’s important to remember that if the underlying business remains solid, the share price could recover after a temporary downturn.
To make informed decisions, focus on the business itself.
Determine whether the cause of the price drop is a short-term issue or a permanent change.
Also, consider whether the decline is due to negative sentiment or triggered by a specific bad news event or corporate announcement.
The Salad Oil Scandal of 1963, involving American Express (NYSE: AXP), serves as a striking example of this scenario.
The scandal revolved around loans tied to collateral that were supposed to be physical inventories of salad oil. However, American Express was duped when it discovered that the containers supposedly holding the oil were actually filled with seawater.
As a result, the company’s share price plummeted by over 50 per cent.
At this moment, famed investor Warren Buffett, who had a stake in American Express at the time, chose to buy more shares rather than sell.
The veteran investor was confident that American Express’s reputation remained intact despite the scandal.
A more recent example is McDonald’s (NYSE: MCD), which experienced a 5 per cent drop in its share price after news of an E. Coli outbreak that led to one death and sickened many others.
While this incident highlighted a critical food safety issue for McDonald’s, it shouldn’t overshadow the company’s long-term reputation.
A similar situation occurred with Chipotle Mexican Grill (NYSE: CMG) in December 2015, when 514 people fell ill due to Norovirus and E. Coli infections.
At that time, Chipotle’s share price plummeted by a third, dropping from US$15 to US$9.90.
However, the company made a strong recovery, and its share price has now soared to around US$59 – nearly six times the low it hit during the food poisoning crisis.
These examples highlight the dangers of selling in a panic when bad news arises, without first determining whether the business is permanently impacted.
Ensure you have sufficient cash
A third scenario that might push you to sell is when you spot new enticing investment opportunities but find yourself short on cash.
Under the circumstances, you may feel pressured to sell just to free up capital for another stock purchase.
The key takeaway here is to always keep some cash on hand to seize opportunities as they arise.
Having cash available alleviates the stress of needing to sell stocks to raise funds.
Ironically, investors often need cash for attractive buys during bear markets, which typically means locking in significant losses since share prices are lower due to negative sentiment.
To avoid this predicament, consider investing in dividend-paying stocks that can generate cash flow in both good and bad times.
These stocks will provide the cash you need to continue investing rather than forcing you to sell your holdings.
Additionally, maintaining an opportunity fund sourced from savings and bonuses can help ensure you have sufficient liquidity.
This way, you’ll have a ready pool of cash to deploy whenever a promising opportunity arises.
Get Smart: Think before you sell
The three scenarios above highlight why you should stop and think carefully before selling a stock.
Before making any hasty decisions, take a close look at the underlying business and its performance.
While there can be valid reasons to sell a stock in favour of a better opportunity, the challenge lies in evaluating the merits and risks of one investment compared to another.
This isn’t a simple task; it requires careful judgment and estimates.
In many cases, the best strategy may be to stay invested in the stocks you already own.
You should seriously consider selling only when the fundamentals have deteriorated to a point where the business can no longer recover.
Note: An earlier version of this article appeared in The Business Times.
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Disclosure: Royston Yang owns shares of DBS Group.
