The decision to sell a stock is as important as buying a good one. One’s ability to make money in stock investment involves two key decisions: buying and selling at the right time. It is as difficult to time a sale as it is to buy.
One needs to manage greed and fear at the time of selling a stock. Here, one needs to be as methodical as possible, removing any emotional bias from the decision. Most importantly, one needs to understand that the decision to when sell stocks should never be based on stock price. One should always dissociate from the price and base it on the health of the underlying business.
Selling a good stock early may lead to the investor missing out on the wealth creation even after picking the right ones. At the same time, holding on to poor companies may lead to capital loss, besides the opportunity cost of not investing in other good companies.
There are some commonly used methods that can help one make the process as methodical as possible, and remove any emotional bias from the decision.
Ideally, the ‘sell’ decision should be based on some set parameters such as the company’s operating performance and any change in the regulatory and business environment. Before buying a stock one should do some homework on a stock and pen down the rationale behind the decision. One should prepare a checklist and hold a stock as long as it respects those rationale – be it operating performance, earnings, management confidence about the growth of the company and others. If a company’s earnings are good and ahead of expectations, then one should continue to hold the stock.
Investors should seriously consider selling a stock if the rationale for buying it is flawed. This means, if the underlying variables have changed, and that may have an impact on the operations or there is a change in the business dynamics whose impact does not look temporary or there are other signs of weaknesses in the business model, then one should reduce his holding or sell.
One should also consider selling a stock if the price escalates to a point where it no longer reflects the underlying value of the business. Investors should also consider selling a stock when the company’s valuation becomes significantly higher than its peers. In another situation, if one sees better opportunities that have the potential to deliver higher returns, they may sell one holding and opt for the better opportunity.
(DK Aggarwal is the CMD of SMC Investments and Advisors)