For making wealth in stock markets, knowing when to sell stocks is equally important as knowing when to buy stocks. The investor should not end up selling those stocks early, which go on to make millions for their shareholders. At the same time, the investor should not keep on holding a stock even when it shows the signs of deteriorating business situation. Therefore, deciding when to sell stocks becomes a trickier decision than buying them.
The current article aims to help the investor in making the sell decision about a stock.
I believe that an investor should invest in stocks with a long-term perspective. The targeted time horizon should not be in months or years but in decades. Legendary investor, Warren Buffett also advised the same to investors in his 2014 letter:
“Since I know of no way to reliably predict market movements, I recommend that you purchase Berkshire shares only if you expect to hold them for at least five years. Those who seek short-term profits should look elsewhere.”
“For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant.”
Holding a stock for decades is essential; however, the investor needs to make sure that she is holding only good stocks for these decades. Therefore, monitoring the stocks in the portfolio and taking the sell decision at the appropriate time becomes essential. Otherwise, the investor would find her limited capital stuck in suboptimal businesses, which exposes her to opportunity cost. Opportunity cost means that instead of keeping money in poorly performing companies; she could have invested her money in stocks of good performing companies and earned higher returns.
Myths around When to Sell Stocks
While interacting with many investors, I have come across many common approaches, which different investors follow to decide when to sell stocks in their portfolio. Many of these approaches are based on the profit criteria.
- Sell when stock doubles or goes up X% from the buying price
- Whenever a stock investment turns into profit, keep a trailing stop-loss so that an investor does not forgo the profits already accrued.
- Whenever a stock investment turns into profits, then sell stocks equal to the initial investment. It will ensure that remaining stocks are at zero cost to the investor and she can hold them despite steep fall in stock prices in future.
These approaches of deciding when to sell stocks lead the investor to think about booking profits the moment the stock price rises above her buying price. These approaches invariably lead to one outcome: the investor gets out of her profitable stock investments early and fails to capitalize on the true wealth-building opportunities in stock markets. Therefore, the investor should avoid these approaches to taking the ‘sell decision’ based on profit criteria.
We know that stock investments have the potential of increasing multiple of times in value, also known as Multibaggers. Many investors have seen their stocks turn five, ten or even hundred-baggers. However, many other investors end up selling their stock investments early and miss out on the wealth creation. These investors do not want to miss the unrealized profits, however small such profits are. It highlights the need for the essential qualities of stock market investors: patience and emotional control.
An investor should always remember that for any stock to be a hundred-bagger, it would pass through stages of two-bagger, ten-bagger and fifty-bagger. If an investor is not able to control her emotions and hold on to stocks on this journey, she would always end up getting suboptimal returns in stock markets. This brings us to the cardinal rule of investing in stock markets:
Never sell your good stocks
However, at the same time, the investor should avoid being stuck in laggards. Therefore, the investor should actively monitor her portfolio. She should identify the signs of weakness in portfolio companies and update her views on the stocks accordingly. This would help her decide when to sell stocks.
Deciding When to Sell Stocks: Guidelines
I believe that the sell decision should never be based on the stock price, let it be the current market price of the stock or the buying price of the investor. The sell decision should always be dissociated from its price and seen in the light of the business characteristics of underlying companies. I believe that the following criteria are a good guide for deciding when to sell stocks:
1) Deteriorating operating performance of the company:
An investor should monitor the operating performance of the company at an annual interval. An investor should take note of signs of business weakness like:
a) Declining sales revenue year on year:
An investor should analyse the portfolio companies whose sales witness decline year on year. At least two consecutive years of declining sales are essential before the investor makes any conclusive decision about sales decline. The investor should not become worried about changing trends in quarterly sales performance.
b) Declining profitability levels year on year:
An investor should monitor both operating and net profit margins. She should become cautious if the profitability margins are decreasing year on year.
c) Declining operating efficiency parameters year on year:
Declining fixed asset turnover ratio, declining inventory turnover ratio and increasing receivables days: it indicates that the management is not able to use assets of the company efficiently and that profits are being stuck in working capital.
d) Continuously increasing debt/leverage year on year to fund business operations.
These are the signs of developing weaknesses in the business model of the company. If after analysis, the investor concludes that the business advantage of the company has deteriorated, then she should sell it without thinking about existing profit/loss made on the investment.
However, it is essential that investor should notice the deteriorating trend of annual values in these parameters for at least two consecutive years before getting worried about them. It is advised that the investor should not become worried about fluctuating quarterly performances.
In any business, short-term variations in performance are bound to happen and if the investor does not ignore them, then she might end up selling some great investment at the most inopportune time. Such times of temporary suboptimal performance are the best times to increase investments in stocks.
2) Government starts interfering with pricing policy and profitability:
Another profound thought which influences the decision of when to sell stocks is the situation when any company is not able to price its products freely.
A business should be able to earn the maximum return on its assets, which it can while facing the competitive pressures. An investor should be wary of investing in companies where the government decides the pricing of products or puts a cap on the profitability of the companies. However, if the investor finds that any company in her portfolio, which was earlier not exposed to such government regulation, has now come under such rules, then she should consider selling the stocks of this company.
Gujarat State Petronet Limited and Indraprastha Gas Limited faced such a situation in 2012, when the regulator, Petroleum and Natural Gas Regulatory Board, restricted their profitability.
Most of the times regulated profitability environment leads to sub-optimal returns for investors. Therefore, she should sell such stocks irrespective of her investment being in profit or loss.
3) Change in business dynamics whose impact does not sound temporary:
An investor should keep on updating herself about the developments affecting her portfolio stocks. In case she comes across any adverse development, which can affect her companies, then she should analyse whether the resultant impact would be temporary. If she concludes that the impact of such adverse development would be long-lasting and the company would not be able to recover, then she should sell her investments in such company. Such sell decisions should not be based on current market price or existing profit/loss on her investment.
A small-cap glass manufacturer Haldyn Glass Limited faced such a situation in Sept-Oct 2014 when Petroleumand Natural Gas Regulatory Board (PNGRB) decided to cut the supply of natural gas to many companies in Gujarat including Haldyn Glass Limited.
The lobby fighting against the gas cut, South Gujarat Small Gas Consumers Association, does not bear very high influence. It could not affect the decision of gas supply cut. It resulted in plant shutdowns by most of the affected players. Haldyn had to cut its production capacity by 20%.
4) Portfolio contains too many stocks and effective monitoring of these stocks has become difficult:
As mentioned above, it is essential that an investor should monitor stocks in her portfolio for related development.
However, the monitoring exercise that consists of ongoing monitoring, quarterly monitoring and annual monitoring might become time-consuming, if an investor has too many stocks in her portfolio. Therefore, if an investor notices that it is becoming cumbersome for her to effectively monitor all the stocks in her portfolio, then she should identify and sell weak stocks from her portfolio. Such selling should be done without considering current price or unrealized profits/losses in the weak stocks.
This would ensure that the investor has a manageable portfolio of good stocks, which would have a higher probability of creating wealth over the long term.
5) A stock is a very small portion of the portfolio:
Many times, the investor invests in a company, whose stock price starts rising fast and soon enough, its price crosses the levels where the investor does not feel comfortable putting additional money in it.
Such instances lead to situations where the company has been performing very well and its stock price has multiplied many times. However, because of no additional investment, soon, the stock becomes a very small portion of the overall portfolio. In such situations, even huge returns in this stock would have only a modest impact on the overall portfolio. However, the presence of this stock in the portfolio adds to the monitoring burden on the investor.
I believe that in such scenarios, the investor should pray that the stock price of this company falls to attractive levels so that she can put additional investments in it to make it a reasonable portion of her portfolio. Otherwise, the investor should consider selling this stock, because the efforts put to monitor a small investment might be much more than the return that might accrue from it.
Checklist for selling a stock
- The deteriorating operating performance of the company
- Government starts interfering with pricing policy and profitability
- Change in business dynamics whose impact does not sound temporary.
- The portfolio contains too many stocks and effective monitoring of these stocks has become difficult
- A stock is a very small portion of the portfolio
This concludes the current article in which we discussed the various factors, which should help the investor take ‘sell decision’ about her stocks.
Selling decision is as important as buying good stocks. It is crucial as selling a good stock early would lead to the investor missing the wealth creation despite investing in good opportunities. Moreover, holding on to poor companies would lead to capital losses as well as the opportunity cost of not investing in other good companies.
In the article, we learned that the sell decision should not be based on the gains or losses, which the investor has made from the stock. Sell decision should instead be based on the parameters like operating performance, changing regulatory & business environment and portfolio composition.
Factors affecting the sell decision are very abstract and subjective. It is very likely that the investor would find that the stock sold by her have risen in price after she sold them. However, the investor should note that short-term stock movements are not always related to stock fundamentals. It is pertinent to quote Warren Buffett here, from his 2014 letter to Berkshire Hathaway shareholders:
“For those investors who plan to sell within a year or two after their purchase, I can offer no assurances, whatever the entry price. Movements of the general stock market during such abbreviated periods will likely be far more important in determining your results than the concomitant change in the intrinsic value of your Berkshire shares. As Ben Graham said many decades ago: “In the short-term the market is a voting machine; in the long-run it acts as a weighing machine.” Occasionally, the voting decisions of investors – amateurs and professionals alike – border on lunacy”
It is therefore suggested that the investor should ignore short-term price movements and keep on taking her investment decisions based on fundamentals.
Let us now get further clarifications about selling stock by answering important queries asked by investors:
Investors’ Queries about Selling Stocks
Should we sell if the stock price declines significantly?
What risk management process do you have in place?
It is possible that the stock you have invested in can crash after your purchase due to various reasons. Usually, the bad news comes in after the stock has completed a huge decline and the investor suffers huge losses. You may be following a process to get out of the stock in the event of a huge decline and minimize your loss.
Thanks for writing to me!
We understand from your comment that you believe that fall in stock price is bad for an investor. We believe that it is not so. It gives the investor to accumulate the stock at lower levels.
It is possible that the stock an investor has invested in can crash after her purchase due to various reasons. However, if the investor becomes worried about every decline in market price, then she should learn about the required qualities from a stock market investor.
One may read the below article for our view on required attributes from a stock market investor, in which patience and emotional stability in times of price declines/market corrections is paramount:
We do follow a framework to sell stocks. However, none of our selling criteria is dependent upon the current market price of the stock. You may read our criteria for selling a stock in the above article.
We believe in continuous monitoring of stocks in our portfolio. Therefore, whenever, the stock price falls, then we check if the fundamentals of the company are intact. If yes, then, we check whether it is still in our buying range i.e. if its PE ratio is less than our investable PE ratio.
If the company has its fundamental strength intact and its stock price is lower than our investable PE ratio, then we become happy that the stock price has declined. During these times, we buy more quantify of such a stock.
Hope it clarifies your queries!
Do we sell a stock on overvaluation/ P/E re-rating/expansion?
Thanks for your feedback. I am happy that you liked the articles.
If any stock in my portfolio, which I bought at a low P/E ratio starts trading at a higher P/E ratio, I do not think about selling it. I only stop incremental investments in it and start looking for new stock to add to my portfolio. The high P/E stock becomes a plant which no longer needs watering, just monitoring to see if it catches any disease in future.
I sell a company when its business dynamics take a hit for worse, which I believe might be irreversible. If business advantage is lost, then I sell the company irrespective of P/E levels. However, if I believe that adverse situation is temporary then I increase my investment in it as that becomes a golden opportunity to accumulate the stock.
Hope it clarifies your query.
Should we invest in stocks with a target price in mind?
Dear sir, your articles are very helpful for beginners like me. I did my investments without proper knowledge and based on tips. However, after losing my money, I have started studying.
I have a doubt. Is it wrong to stick to the expected returns?
I have my investment in Bliss GVS Pharma Limited, where I’m currently getting nearly 45% profit. But, as I was expecting a 100% profit, I didn’t sell it when it reached nearly 65% profit. I’ve never got a 100% profit in my investments. At least, I expect this counter to hit 100% profit. My average pricing is ₹73. Holding it from nearly 6 months.
Thanks in advance.
Thanks for your feedback.
I do not believe in buying a company with a target price in mind. It is a losing strategy that leads an investor to sell her winning positions with limited profits and whereas she ends up holding losing investments longer awaiting to achieve breakeven.
If an investor keeps a target price in mind, she would never be able to get multibaggers in her portfolio.
Warren Buffett acknowledges that most of his wealth is a result of about 8-10 good investment decisions like Coca Cola, Gillette, Wells Fargo, Washington Post etc. If he had kept a target price in mind, his wealth would have been languishing at few hundred million dollars and not billions which he owns today.
Therefore, I would suggest you not to keep an expected return in mind and stay invested till the time business strength of the company is intact.
Bliss GVS Pharma Limited:
I glanced through the financial numbers of Bliss GVS Pharma Limited. The numbers though looking attractive at the first look, are hiding some significant developments concerning the business operations of the company.
You may read about my views on Bliss GVS Pharma Limited in the following article: Analysis: Bliss GVS Pharma Limited
Hope it helps to resolve your query.
Dear Dr Vijay
I am reading the article on how to analyse companies. I am a big fan of your blog. I want to know:
- How to decide the target price of a stock when you buy and
- Secondly, your exit strategy when you buy a stock.
Thanks for writing to me! I am happy that you liked the articles.
Target price (upper cutoff purchase price) is based on the valuation level at which an investor is comfortable to buy any stock. I follow a checklist approach and prefer buying into companies at a low P/E ratio. So P/E ratio calculated as per the criteria mentioned in the below article acts as a tentative upper cutoff price for me.
An investor should hold the shares till the time the stock is showing good business performance. A company should be sold only when its business gets deteriorated in an irreversible manner. Market price should not be the factor to decide about selling a stock.
Hope it helps.
I have some questions regarding the stock shortlisting. It will be great if you can help in this.
- So, once after you shortlist some stocks, do you set any target price for buying the shortlisted stock?
I highly appreciate your work and I would like to know your opinion on these things.
Thanks for writing to us! We are happy that you have found our work useful!
We do not keep target prices for stocks. This is due to the following reasons:
- Stocks have the habit of not responding even to good business performance for years altogether and
- When good stocks rise on recognition by the markets, then there is no limit to what extent they may rise.
Therefore, we choose to invest in stocks, which we feel are fundamentally good and stay with them without any return expectations.
Hope it answers your queries.
All the best for your investing journey!
Dr Vijay Malik
What do we do when the growth of a company slows down after P/E rerating?
How can an investor learn about industries, which are new to her?
Hi Dr Vijay,
Hope you are doing well. I have a few questions that I hope you can shed some light on:
- P/E rerating: How should you evaluate whether to hold/sell a stock whose P/E let’s say has increased from 8 at the time of purchase to 70, with key facts being that sales growth has slowed down, but its sales and dividend yield is comparable to industry leaders now, and profitability remains the same.
- Resources: Could you provide some resources on how different industries can be evaluated like you explained “percentage of completion method is used for real estate sector” and how it is different to evaluate a bank like for its SCF especially its CFO. If you could provide some links and resources I could look up, I would be grateful.
A follow up to the above question: Could you also provide guidance on how to widen one’s circle of competence?
Thanks for writing to us!
1) We do not sell portfolio stocks if they become overvalued. We have held stocks rising from P/E of 6 to about 40 and we have been ok with it. We have not seen valuations rise to 70 P/E until now in our portfolio so we can only speculate what our reaction would be in such a scenario. However, we believe that our approach would not change provided the fundamentals of the company are intact.
2) You may refer to the following article to learn more about industries, which might be new to you and to increase the circle of competence:
All the best for your investing journey!
Dr Vijay Malik
This ends the current article about how to decide when to sell stocks. Going ahead, I would write about the portfolio composition, optimal number of stocks and diversification.
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I would like to know about the parameters you follow for deciding when to sell stocks in your portfolio. The checklists or parameters you find important for investment decision making and any other inputs that you believe would improve help the author and the readers of the website. You may write your inputs in the comments below.