When to sell a stock

CMC Markets

Investors, advisors and financial service providers devote a lot of energy to determining which stocks to buy, and when to buy them. This is only half of most investment strategies. Knowing which stocks to sell, and when to sell them, is equally important.

The buy and hold forever investment strategy is a traditional approach. Over longer timeframes (more than twenty years), it can be very powerful, especially where dividends are re-invested. It also delivers in bull markets, but in recent years the local share market has largely traded sideways, albeit with an upward bias. The market rewards are going to good stock-pickers and active investors.

Stock-picking and active investment require investors to sell, as well as buy stocks. Yet many experts are surprisingly mute on which stocks to sell, and the timing of these actions. How should investors decide?

Correct investment decisions depend on individual circumstances as well as market factors. Individual investors must decide for themselves whether the following information applies to their situation. Nonetheless, here are some of the better reasons that successful investors sell stocks:

The market has changed

Investors convinced that a significant market correction is coming have many avenues of action available. Some of these involve selling stocks. A strong conviction could see an investor sell their total portfolio, although there are significant underperformance risks should the market continue to rise. Others may prefer to give every stock holding a haircut, reducing all holdings. Still others may weed their portfolio, using some of the criteria described below

The company has changed

Companies regularly change strategy. This often parallels changes in senior executive or board personnel. Extending or reducing the product, re-positioning a brand or market segment focus, and re-shaping supply chains are just some of the levers new management can pull. If a company’s strategy no longer matches the reasons an investment bought its shares, it may be time to sell.

Significant transactions may also prompt investor action.  A company taking on debt to purchase an asset, operation or competitor, changes the investment thesis. Similarly, when Wesfarmers spun off Coles supermarkets, investors faced a changed investment proposition. Whether investors chose to sell Coles, sell Wesfarmers, or hold or sell both, the transaction should have prompted a re-think from shareholders.

In a perfect world every management team would deliver on its strategy. When operating results repeatedly miss goals, or management fail to implement promised improvement, perceptions of the company change. Regular under performance is another possible selling trigger.

The share price has change

A significantly higher share price is one of the more pleasant reasons to sell a share. Where gains are meaningful, and especially where investors are pursuing an active strategy, locking in profits is another potential selling criterion. Some investors will sell when a stock they saw as undervalued reaches what they see as fair value. Others will wait for overvalued territory, or even ridiculously overvalued levels, depending on their individual investment approaches.

A sharp share price drop is a sign that market thinking about a company has changed quickly. A profit warning, a disappointing result, or even no apparent reason can see a stock drop like stone. This is a clear signal to shareholders to consider their ongoing holding of that stock, regardless of their eventual decision.

Another price signal to investors is when a share drops like a drunken uncle. It staggers, drops, rights itself, and then falls again. This can be a sign of continuing trouble at an operational level, and is often caused by a series of analysts’ earnings downgrades. It may be perfectly reasonably for investors to hold, with a view to riding out temporary trouble. However a shaky share price, and an unfolding downtrend, is another potential selling factor.

The investor’s circumstances have changed

Lastly, investors may consider a sale when their own circumstances change. Approaching retirement may mean a changing risk profile, prompting investors to reduce exposure to higher growth, higher risk stocks for those with characteristics that are more defensive. Investors do not have unlimited capital. A better investment opportunity may spur an investor to re-consider a current shareholding.

Any selling decision is a matter for the individual, and uncertain investors should seek independent advice.  But selling stocks for good reasons is an under-rated aspect of successful investment.

This article first appeared in the Australian Financial Review