Tuesday, October 6, 2009

When to Sell a Stock?

The most intriguing question in the stock market has always been “When to Sell a Stock? This is in fact as much important as “When to Buy a Stock?” The selling point depends on what kind of investor you are. I just leave out the day traders as they have to sell it on the same day and group other investors into

Short Term Investors
Medium / Long term Investors

The selling point for the short term investors sometime differs from the Medium / Long term investors. If we consider 5 years or more as “Long Term”, then we would experience several corrections (over 5 year period) which would be very significant and each one of the troughs could be a selling point and one can sell at the troughs and then buy back the same stock at a lower price.

Short Term Example:

If you are a short term investor, it is better to fix a selling price or return percentage while you buy the stock and sell it as soon as the stock hits the target price. Because, often times price decline happens apparently for no reason and may be that’s the reason technical analysis was born in the first place.

Example: Venus Remedies

This stock was trading at Rs.210 in July 2009 and company has good fundamentals. In the recent rally, the stock reached the short term peak of Rs.310 (50% returns) and started declining and is available now for Rs.220. There was no change in the company fundamentals and nothing has changed since July. So, if one had set the “Target Price” in the first place, he / she could have profited significantly and can buy the same stock now at a lower price. Hence, setting a “Target Price” is one way of identifying the selling point.

Long Term Example

Long Term selling point should ideally be a “Maturity” value for your investments and it is one of the most difficult things to come up with. Again setting up a “Target Price” would be very helpful for the long term investment as well, but it is one of the very difficult things that I can think of. Because, in the short term, one can set 50% return as the target price. But it can’t be the “Selling Point” for the long term investment. If the company is really good and you fix the “Target Price” as 50% return, then you could potentially miss the multibagger. So, my suggestion would be to keep invested as long as the fundamental does not change significantly and market sentiment is positive. If you feel the market is reaching unsustainable levels, then just sell it even before peaking. Two things can be done to sell the long term investment.

1. Identifying the Market Peak and sell
2. Sell when the stock is heating way above the company fundamentals

Example: Reliance capital

Reliance Capital was trading at Rs.2875 on Jan 10, 2008 and the expected earnings per share for the full year at that time was about Rs.45 (PE Multiple of 64). Even if you have failed in identifying the “Unsustainable market” levels (SENSEX breached 21000 during that time), you could have certainly predicted that valuation for reliance capital at Rs.2875 was stretched for its fundamentals. Again it is a risk we need to take. Sometimes you might sell the stock thinking that the stock has reached the peak, but market sentiment or over optimism may drive up the stock price to unbelievable levels. But it is better to take profits rather than become a slave to the market crash.

General Guidelines to sell a Stock

The following points needs to be considered to sell a stock irrespective of the duration of investment. But, it is important to remember that you can’t get the “Selling Point” right all the time. Selling signals can come either from company itself or from the market.

Company Related Changes

Change in Fundamentals is the most important thing that one needs to consider while selling a stock. Certainly the following are the ones that come to my mind.

1. Earnings stop growing or Decline in earnings
2. Slow growth of Operating Cash Flow
3. Decline in Market Share
4. Negative Regulatory action specific to the company
5. No New Products or Enhancements
6. Decline in research spending
7. Change in Top Management
8. Increase in Debt without any expansion plans
9. Decline in the same store sales
10. Acquiring seemingly unrelated companies or relying on it for expansion
11. Increase in raw material cost
12. Patent Expirations
13. Cutting costs as a way of keeping the earnings

Market Related Changes

1. Stock is heating up way above the fundamentals
Ex: PE of company A is 60 without any specific reason while the peers are trading at the PE of 20.

2. Market in general is reaching new highs signaling over optimism
3. Insider Selling or even no insider buying
4. Increased competition
5. Negative Regulation for the entire industry
Ex: Just Yesterday (Oct 06, 2009) we saw TRAI announcing per second tariff plan and all the telecom stocks declined by 10%.

These are some of the points that I could come up with to identify the “Selling Point” but there could be others specific to the situation. I expect more discussions in the comments section related to this post as it would help everyone to learn few things in terms of selling a stock.

Kumaran Seenivasan.


Shabu's October 7, 2009 at 8:17 AM  

Dear Kumaran,

A worthy and informative post again. You have included most of the symptoms to exit from a stock. There is hardly anything left, I think.

Good work and keep it up.

Ajay October 7, 2009 at 10:47 PM  

Very good post.
Here is similar reading: http://www.moneycontrol.com/news/management/dont-falllovestocks-jhunjhunwala_172914.html

Faisal Humayun October 8, 2009 at 4:36 AM  

Great post and really useful for making a selling decision.

Besides fundamentals and other macro factors. Once can surely consider selling a stock when all analyst, investment community and people in general are running after the stock of recommending buying it. That's when its most overvalued.

In the same way if one has to buy a stock then some of the best buys are where very few people have noticed about the company...it has very few analyst recommendations...has very low FII holding...but is a good stock (as per one's observation).

We find these stocks often but don't have the confidence to buy it since we feel others are not talking about it or recommending it.But that's when multibaggers can be spotted.

Kumaran October 8, 2009 at 7:27 AM  

Thanks All for your comments. Faisal, thanks for adding the important points which I forgot to include.


Krishna,  October 10, 2009 at 12:40 AM  

Kumaran Very good article...Thanks for posting..

Adding to it..

Human Psychology also plays a major part in stock market.
our instinct tell us to buy stocks when prices are high and to sell stocks when prices are low

There are two key reasons for this - social proof and scarcity.
Social Proof - If we see others buying stocks, then it must be a good time to buy. The same goes for when everyone else is selling.

scarcity- As the market rises, stocks at lower prices become more and more scarce, which creates more buying, which makes them more scarce, and on and on it goes until the music stops.

Because the rules of scarcity and social proof are steering us to buy high, and sell low. In this case, "we" are our own worst enemies.

To counter the psychological forces arrayed against us,

Experts suggests two ways to counter scarcity - 1) Think before you act, and 2) Remind yourself that the "utility of the item remains the same" , no matter the scarcity, loss, or competition.


GOVIND GADIYAR October 24, 2009 at 9:39 PM  

Dear Kumaran Saar

You are doing great job. Keep it up

Anonymous,  November 6, 2009 at 10:20 AM  

kumaran good. comments by Faisal very insightful.


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