Half way through writing part one of this series, I realised that this is actually a much more complex issue than I can do justice to in a single article. As such, I’ve decided to split the topic into a series. In the first article, I covered my thoughts on selling; as a first rule, try not to!
If you have to, as with all things investing related, it is best to have a set of rules and guidelines to ensure you do so in an orderly and considered fashion. One of the most important factors for knowing when to sell comes from a valuation perspective. There are a number of different issues to consider for valuing a company; cash flow, profit margin, net asset value, future growth prospects, net debt; all of which I analyse when considering whether to sell an asset.
If the price to earnings ratio starts to creep up towards 20 then I become more interested in selling it (to be honest, anything over 15 starts to make me a little cautious).
For investment trusts and REITs, I also like to consider the price to net asset value – I almost always refuse to buy at a premium and when holding, don’t like the premium to become too big. Anything over around 10% makes me start to consider taking a profit.
This automatically helps me to prune a number of holdings which the market may love a little too much. Excellent companies are worth a premium valuation, but they are few and far between and the larger the premium becomes the riskier the position is.
When I buy a stock, I also set a target price based on cash flow or assets, and I log this in the diary I use to record all my positions and trades. Again, this target may change over time – I try to recalculate on an annual basis – but when the target is reached it is an opportunity to consider taking some profit.
Reacting to bad news
Anyone with a reasonable length of time in the market will be used to waking up one morning to see the dreaded ‘profit warning’ RNS or one of its terrible partners in crime. These little announcements have the potential to send the price of what looks like a great company fluttering around worse than a handkerchief in a storm.
As with most things, reacting in a panic is rarely the best option. If I wake up to the alert, I usually have a few hours before markets open; at any rate, the market can react quicker than me and so it often sends the price plummeting down before you can even contact your broker. It’s always a bit gut wrenching. My fiancé has seen me blanche more than once when opening my emails in the morning – fortunately, I have time to reflect on matters during my commute and have generally overcome the urge to react by the time I get to the office.
As I steer clear of over indebted companies or speculative pre-revenue/low profit businesses, I don’t find it too difficult to keep calm. Profit warnings are a fact of life and often create a buying opportunity when the rest of the market is running about panic selling and crashing the price. I prefer to ride the wave and average down in 80% of cases.
How do I sell
Some investors advocate ‘top slicing’ where they only sell part of a position that has shown strong growth. I’m generally not a fan of this – in fact, I don’t think I’ve ever done it – as it feels a little like uncertainty. If I’m not sure I should be selling, then more analysis and consideration is needed. If I determine to sell, then why not sell all my position? I find the danger with top slicing is also that an investor can over-accumulate assets, weakening their portfolio through ‘diworsification’ I try to keep logical about selling. Once the decision is made, execute the trade and move on. Some investors seem to find a perverse pleasure in watching a share after they have divested themselves of a position. I see such behaviour as fundamentally wasted time – as you no longer have a stake in the company, what difference does it make what the price does?