When to Sell Stocks

June 4, 2009 | Comments (11)

One of the hardest aspects I find in investing is not searching for value stock ideas, analyzing businesses or even calculating intrinsic value. I find selling to be one of the hardest and something I am terrible at, which explains why this post is only the second I’ve ever written on the subject.

Mostly because I’ve only ever been long in any investment position and partly because I’m a greedy human being.

Basics of When to Sell Stock

You would have already heard the basics to selling stocks (including this blog). The basics to selling is:

  • selling once it reaches fair intrinsic value
  • acknowledging a mistake in the original thesis
  • change in company fundamentals
  • better stock idea or any other investment opportunity comes along
  • in an emergency

It is Difficult Selling Stocks

The problem is that on far too many occasions, I haven’t sold. My greed caused me to try and pick up pennies in front of a bulldozer. Sometimes, I get away with it but once in a while I’m run over and it hurts. This is precisely what happened with my EMAG arbitrage.

Although I was confident that the deal would go through, other completely out of control external factors caused the merger to blow up and my position with it. Just one day before the deadline, I was risking my 50% return (big position at the time) for a few pennies.

But I look back at the situation, recall how I felt after seeing my portfolio drop by 30%, re-read what I wrote and it is enlightening. It helps in reminding me of the lack of discipline and objectiveness.

Learning from Mistakes

With good mid to long term companies that I own, although it reached fair value, I did not sell because I was content with the business operations. This has now become an outdated reason for my continuing to hold.

No matter how good the company, I now prefer to sell once it reaches fair value.

Back when I first purchased KTII and ATW, I was fortunate enough to see the price reach my fair value target within a few months. I held on hoping for it to continue its upward trend. Then the market turned and rather than being cashed out and having a cash balance for new opportunities, these positions dropped like everything else.

This is an example of how holding cash for the next opportunity isn’t so bad.

Selling for Better Opportunities

For someone that goes through quite a number of stocks, I never fully understood how I could go about selling a position each time a better one came along.

If I bought a company one week and next week I come across another equally if not better opportunity, I would have to sell according to the basic rule. But what happens if this occurs every week?

Just like how there will always be someone smarter than you, there is a stock that will always be better than yours.

Selling Losing Positions

When selling losing positions, there are 2 groups of people.

  1. A group that waits for the stock to recover so that they do not incur a loss, even if it takes several years to recover
  2. Sell even though the return is down 50% because of a new 100+% potential idea

Which would you choose? Most people would say they are number 2 but the majority is in group 1.

I’ve now moved from group 1 to group 2. e.g. Although I like KSWS with its strong balance sheet and experienced management, I sold it and invested in two other positions that have both yielded 20% and 50%.

Mechanical Selling and Trailing Stops

One idea I have been pondering is entering a sell order after my purchase at my fair value. That way if the stock was to run up, it would sell automatically without my intervention.

Other people also swear by the use of trailing stops in protecting gains.

When Should I Sell?

Still asking this question? It may be a hint that you should sell now. Without conviction, there is no reason to be holding.

Disclosure

I hold KTII and ATW at the time of writing

  • http://www.dividendgrowthinvestor.com Dividend Growth Investor

    I guess it depends why you bought the stock in the first place. If your entry criteria is no longer valid,then why stay and hope for the best?

    Dividend Growth Investor’s last blog post..Colgate Palmolive (CL) Dividend Stock Analysis

  • http://invest.obtusely.com/ The Obtuse Investor

    I suffer from something known as “premature allocation”. So more often than not, I find myself in a position where a long term business that I have bought keeps on falling below my cost price. And, if there is a secular bear market, then sometimes many other, just as promising, businesses fall to a price where they are even more attractive.

    What do I do? I stick to my business, and if I have fire power left, I average down my cost. I follow a handful of excellent businesses for years and wait for the opportunity to buy them. Just because some other business that I don’t know very well is cheap too, doesn’t mean that I should run after that one.

    It is like marriage. You find a wife/husband– you know them thoroughly and invest a great time and money into them (in form of a family, etc.). Just because you see some “hottie” walking around, you don’t just dump your long term investment in your family.

    I like to own businesses that will last a long time, i.e. 30-80% of my lifetime.

    When to sell them? I still am not sure; but selling them in a depressed market seems foolish even if it earns a handful of more yield points in the short term.

    The Obtuse Investor’s last blog post..Bernanke’s speech

  • Susan

    Hi Jae, for ATW, if calculated its intrinsic value based on DCF fair value spreadsheet, the result is very bad. The free cash flow is negative. But after analyzing its financial statements, I have to say that the company is actually very good. Could you please give a clue how you did the research for this company? I do not mean to buy the ATW now, but just use it as an example for stock evaluation. Thank you very much.

  • http://www.oldschoolvalue.com Jae Jun

    @ DGI,

    If things change that’s another reason for selling. Hope does kill an investor after all.

    When I first started, I thought of myself as a passive investor. This meant that if a good company reached its intrinsic value, given that it had a good moat, it should continue to perform at its average growth rate over the long run. Also, being long term minded I thought I would be satisfied with, say a 10% annual return.

  • http://www.oldschoolvalue.com Jae Jun

    @ The Obtuse Investor

    Thanks for the thoughtful comment and I completely understand where you’re coming from but I’ve found out that even excellent business lose value and since price follows value, there is always a possibility that my previous estimate may be very wrong. The company may still be great, but if the upside and margin of safety is gone, there is no reason to continue holding.

    However, if the business maintains its value but keeps dropping in price, then its worth adding to the position.

    I like your reference to marriage but I will have to respectfully disagree on this one. While a marriage involves commitment no matter how bad the situation, an investment should be thrown out if things start going sour. If I find a company that I find to offer better returns I will go after it, rather than wait for my initial investment to recover. To me it’s about getting a “satisfactory return”, which is what Graham emphasized. 10% may be satisfactory to some, 15% to others or 25% for me.

    In the end it all points towards what your personality and strategy is focused on. I originally thought I was a buy and hold for 10 years type of guy. Turns out I didn’t know myself too well. I much prefer to get my hands on everything, go through everything, do the hard work and reap the rewards regardless of the timeline, industry or company.

  • http://www.oldschoolvalue.com Jae Jun

    @ Susan

    With the spreadsheet, Atwood’s fair value will be incorrect due to their capital intensive business model. Their FCF growth is rather dismal because they are continually maintaining and investing in their business.

    With ATW, I see 2-3 other competitors you should also be looking at. RIG, DO and HERO.
    RIG is the industry leader with more rigs. I chose ATW because of its size as well as its profitability and past performance.

    So when looking at capital intensive companies, look at their cash flows. Earnings have never meant much so its not that big of a deal.

    Also, read the annual reports about the secured contracts. I’m a bit short on time at the moment but let me know if you need further assistance.

  • http://invest.obtusely.com/ The Obtuse Investor

    @JAE JUN
    Thanks for your response. I have to agree with you that the original purchase reasoning greatly affects the decision to sell.

    The point that I was trying to make, was to say that if one buys with the reasoning to hold for the very long term; i.e. through thick and thin– then one is forced to choose a higher quality of business.

    In that sense, I am simply reiterating Warren Buffett or Charlie Munger’s philosophy. In practice, I seem to follow both the Graham style (that you mentioned) and the Buffett style. I think it is important to not just have one strict rule, but rather a framework to deduce an answer to the great question “when to sell?”

    The Obtuse Investor’s last blog post..Is this Too little, Too late?

  • http://www.oldschoolvalue.com Jae Jun

    A long term hold does require a high quality business, especially if you want to be able to sleep at night.

    Buffett is a master investor of great businesses and so is Munger and you can’t go wrong with those two men. They’ve proved that long term buy and hold is not dead but the only problem with Buffett is that he rarely sells.

    Since his holding period is “forever” I’m speculating that he finds it difficult to always know when to sell as well lol.
    (That was a joke) Buffett had great businesses in JNJ but sold a part of it for a better investment in preferred shares and also sold when realising his mistake with COP.

  • http://www.stockpursuit.com Stock Pursuit

    Congrats on VVTV Jae !

    On the selling, my take is if someone is using strictly fundamentals you have to sell when the valuation gets slightly rich. That is pretty easy to do if you got a good price on the stock. Easier said than done though of course if your holding for years and years.

    ie you have to pretty much predict the future of the company bc they could tap new markets, develop a new product, improve margins/ROI etc. That’s why companies like Apple continue to sport high valuations and keep soaring. I respect Buffett more than any other investor even on his macro economics but I thought about his record a lot and his best investments like Washington Post etc were so good bc he got such a sweet deal “PLUS” took the helm of the company and improved it like a Carl Icahn. So, his success a lot is as much his ability to “improve” a company bc of his size that we can’t do as small investors. He’s also been a genius I feel at predicting our economy. only 1 in 100,000 people can duplicate his strategies effectively I feel.

    The other thing you guys have to realize about valuation and stock picking is most companies will trade with the overall market. I mean just look at this rally.

    Do you really think the fundamentals support such a huge rally in all these companies? for most stocks you are almost better off predicting the overall market and basing your sell decisions on it which sounds crazy but it often works that way. We all think the companies fundi’s are all that matter but the inflows and outflows of capital in the markets decides where and “when” the money managers put capital to work most of the time. Herd mentality. The opportunities to play contrarian and use value investing work more bc the economy booms and busts. Of coures some companies are exceptions but something to think about.

    Stock Pursuit’s last blog post..Solar Stock ESLR Another Set-up

  • http://www.oldschoolvalue.com Jae Jun

    Thanks Mark.

    I don’t plan to sell VVTV anytime soon. Although the gain is nice, it hasn’t reached my intrinsic value yet and I wont be bummed out even if it drops again. Valuation is still too cheap on this one.

    Mr Buffett. A truly great investor but I know that I can’t replicate him and shouldn’t try. There are some things that are outside of my realm and trying to do what he does is one of them. He does buy great companies but what most people forget is what you mentioned. He gets a hellava deal on most of the things he buys that are not available to anyone else.

    Regarding the market, while I agree that the majority of stocks will trade with the market, when it comes to under appreciated and contrarian picks, I think the market doesn’t matter as much. Previously the market was based on fear and dropped the price of everything. This also meant that the market was cheap and the market has realized that to some degree. Problem is that even the crap stuff go up with it.

    In the end, it’s important not to get overwhelmed and overexcited about the current movement. Get out when given the chance.

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