There are a few strategies in investing, you can buy low and sell high, or you could just hold the stock and reap dividends. Either way, your goal is to make money.
However, consistently buying low and selling high is a challenge in practice. How do you know when the stock is high? How can you consistently profit from this strategy year on year?
It’s psychologically challenging
When we see our stock rising above our cost price, we would be tempted to sell it because we’ve already made money. But usually, it tends to rise further and we would be missing out on all the potential gains that would be made if we had not sold it too early. Look at the recent Singapore REIT rally – how many of us sold in the middle of the rally, only to see prices rise by another 10%?
Other times, we sell the stock at a high, perfectly timed, and the stock comes crashing down after. We pat our backs for our foresight and great predictive skills, but ignore the fact that it could be sheer luck.
When people sell stocks, they do it for a variety of reasons, it could be that they’ve already hit their target profit, it could be fundraising or capital recycling, it could that they just wanted to flip a stock for quick profits.
How I execute by sells
After many years of investing, I have found that it is difficult to beat the market, and simply consistently buying and holding stocks can produce a superior return. If you’re into technical analysis then there are ways to time your trades. But in this post, we only look at 3 fundamental reasons why I would sell a stock.
#1 Dramatic deterioration in business conditions and company fundamentals
Industry trends and business conditions constantly change. They react to external stimuli and macroeconomic forces of demand and supply. However, most businesses do not radically experience dramatic deterioration of its fundamentals.
Unless there’s a structural shift of the economy.
Let’s look at two examples in Singapore – SPH and StarHub – which I had maintained a SELL call since three years ago and their stock prices have constantly fallen. It should not surprise many.
Structurally, their industries have been disrupted by technology. SPH has its business model historically focused on print media and advertisements while StarHub operates a domestic telecommunications network and buys rights to cable television. With the advent of social media platforms, video consumption platforms like YouTube and Netflix offering international content for cheap, instant messaging/communications platforms like Telegram, Messenger and Whatsapp, it’s not difficult to paint a grim outlook of their businesses.
These companies also are in the mature stages, paying fat dividends while not reinvesting much into technology and new services. Investors who bought in for their dividend yields a couple of years back would have seen their dividends cut and share prices tank.
Of course, not all traditional businesses that face disruption see the shareholder value erode so drastically. Those that were quick to capitalise on new business models, leverage on technology to become more efficient, and sharpen their customer focus were able to gain new grounds.
#2 Overvaluation grounds
When I buy a stock, it is usually bought at a fair price – either below its book value or at a lower than average P/E ratio. Sometimes due to overly optimistic market sentiments, valuation ratios can get extremely distorted – changing the risk return profile of the stock. As valuations tend to revert to the mean, I might choose to sell stocks when their valuations have reached extremely high, i.e. between 1 to 2 standard deviations from the mean.
#3 Target profit strategy met
I treat this as a trading strategy. I find good stocks with decent market capitalisation and trading volumes, get them at depressed prices following either sharp broad market corrections or temporary negative press (non-structural changes), then sell them once I feel comfortable with my profit margin.
As an example, I did a couple of times with China Life in the past and First REIT recently.
The strategy works because of the following. Broad market sell-offs tend to be indiscriminate, affecting both good and bad stocks. If you have researched about a stock / company and you know it has a great business, strong leadership team and track record, buying in during a sell-off can improve your chances of flipping.
Temporary negative press about a company can also create opportunities for trading. Recently, I executed these strategies for JD.com and First REIT, following negative press on jail charges on JD.com’s CEO Richard Liu and potential sponsor debt issues / Indonesian Rupiah weakness respectively. These events created opportunities for people who believe in reversion to the mean and long-term investors who care about company fundamentals, rather than responding to news and noise, which can always be manipulated by the media.
Always ask yourself why you’d want to sell the stock
Finally, as a parting advise, always ask yourself why you’d want to sell something. Are you a short-term of long-term investor? Are you a speculator or investing to build up your retirement portfolio? Has the fundamentals changed? Is the stock still supportive of your initial investment thesis? Are macroeconomic conditions still supportive?
There are a thousand reasons to sell a stock, but always ask why you bought it in the first place.