Buying shares is easy. We might, for instance, see or hear about a company that we quite like the sound of. Then we try and estimate what the shares might be worth. Some of us might use fundamental analysis. Some might examine charts and technical analysis to work out if the share is cheap or expensive.
Others might rely on brokers, who may even provide us with price targets. If the market price of the share is below what we believe they should be worth, then that might be a good time to buy. It is quite straightforward.
But what happens after we have splashed our cash is the tricky part. Even professional investors can agonise over what to do with certain shares in their portfolios.
Do we, for example, hold onto our winners in the hope of making further gains, or should we think about taking a profit? But what should we do if our shares fall below the price that we have paid for them? Should we hang on for a recovery, or might it better to cut our losses and run? Should we consider averaging down, which is to buy more shares at a cheaper price, so our average holding cost is arithmetically lower?
Hindsight is always 20/20
When to sell is always easy with hindsight. However, there are a few simple rules that could help us decide whether it is a good time to sell. It does require discipline, which is something that many of us could toss to one side when conditions in the market change dramatically. How many times have we found ourselves saying that we could have, should have or would have done something differently?
However, we would not have to blame ourselves too much if we do not lose sight of why we bought the shares originally. So, before we buy a stock, we should jot down our reasons for liking it in the first place.
It can be surprisingly easy to forget why we invested in a particular company months later. So, it can be a good idea to regularly remind ourselves about the reasons for liking a share before we buy it.
For instance, we may have invested in a business because of its commanding position in the market, only to find that its dominance has been eroded over time. Consider a cab operator that has seen its market share gradually eaten away by new ride-hailing companies that are considerably nimbler. It does not mean that the cab firm has turned into a “bad” company overnight. But the original reasons for buying it have changed.
Changing with the times
Mind you, some companies may evolve significantly as they adapt to changing business environments. A company might have caught our attention as a significant owner of shopping malls. But what happens when it merges with a major office landlord?
Again, the thesis for buying the shares has changed. It is akin to ordering fish and chips at a restaurant, only to be served a sirloin steak instead. The steak might be delicious, but it is not what you asked the waiter to bring you.
Growth investors might want to consider selling a share when the opportunities for the company to expand have slowed. These investors are on the lookout for businesses that can either grow their revenue or profit at a fast pace.
But when growth slows, the market is unlikely to be as enthusiastic about them. Consequently, investors might pay less for every dollar of earnings – which has the effect of compressing the valuation, causing the share price to drop.
Being methodical
Value investors are usually very methodical in the way that they look at shares. They will generally assess a share on strict criteria to determine its intrinsic value.
Consequently, value-seekers will normally sell a share once its value has been outed. What happens after they have sold it is of no interest to them. They are on the lookout for the next value opportunity.
Dividend investors are more interested in the income-generating properties of a share. By and large, income investors do not normally sell shares unless the company has decided to stop paying dividends.
As far as income investors are concerned, the share price is less important than the ability of a share to deliver reliable dividends.
Alas, there are no real hard-and-fast rules about when to sell shares. It really depends on what type of investor we are. Therefore, it is important to know which investing discipline is the best one for us to follow.
If we do not know this, then we could find ourselves lurching aimlessly from one share transaction to the next, which is far from ideal. Ironically, whenever we sell shares, there is a buyer out there somewhere who takes an opposing view. Both people cannot possibly be right at the same time – or can they?
Note: An earlier version of this article appeared in The Business Times.
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Disclaimer: David Kuo does not own shares in any of the companies mentioned.
