Selling is the most difficult part of investment management. It is easy to point out the common mistakes than layout a coherent strategy of selling stocks. Let me start with the easy bit.
Mistakes of commission (Mistakes of selling)
Panic selling in a crash: Some people get extremely worried when there is an extraordinary event. They panic and completely exit the market, thus making a temporary loss of capital into a permanent loss of capital.
Selling when the stock returns a predetermined profit: Some people sell stocks once they have an appreciation of a certain percentage or if the stock price hits a certain trigger. This could lead to significant opportunity loss.
Sell when a “pundit” on TV or newspaper says so: Some people sell stocks listening to people who at best have no stakes other than their highly forgettable opinion or at worst it is a “punter” with an hidden agenda.
Mistakes of omission (Mistakes of not selling)
Holding on to poor quality stocks after experiencing a significant loss. Some people hold on to poor quality stock as they have already experienced a significant loss. Selling the stock after a significant fall in price means realizing the loss, and many investors are reluctant to do so. This is classical loss aversion.
Holding on to stock for sentimental reasons: Some people hold on to stocks that are no more representing good businesses as the stocks had delivered impressive results in the past.
Holding when a “pundit” on TV or newspaper says so: Some people hold on to questionable stocks listening to people who at best have no stakes other than their highly forgettable opinion or at worst is some “punter” with an hidden agenda.
Now coming to the tougher part, let’s look at what investing means. When one buys shares in a business they become part owners of the business. One should remember that value of a share is directly related to value of the business. Stock market in the short run can behave as a voting machine fluctuating to the whims of market players but in the long run it acts as a weighing machine, reflecting the underlying value of the business. Serious investors should be interested in the valuation and ignore the day to day fluctuations.
Let’s review the mistakes of omission and commission based on the above premise:
If an external event causes a general market panic and does not impact the fundaments of a business then one should hold on to a stock. For instance “BREXIT” may not impact the sales of ITC, HLL, Dabur etc., in India in a significant way. It does not make sense to sell these stocks in a “BREXIT” panic. This could potentially be a buying opportunity.
If the actions of the management have caused a permanent loss of value then holding on to a stock may not make sense. For instance, holding on to stocks like Bhushan steel or Kingfisher airlines does not make sense as their underlying business has deteriorated.
The price of a stock reflects the underlying value of business. Selling when the stock price has a pre-specified appreciation – does not reflect understanding of the underlying business. For instance, a person who purchased Eicher motors, Page industries, Yes Bank etc., and sold them after a 15% appreciation would end up missing out on the spectacular returns the companies have delivered.
Holding on to stocks because of their spectacular past performance while their current business has deteriorated is also a folly. For instance, holding onto Dr Reddys Labs, ICICI bank, Infosys, Wipro etc may have led to significant opportunity loss over the last few years, although their past performance has been nothing short of spectacular.
Coming to the last and my favorite topic of heeding to investment advice doled out on TV or print articles. You don’t expect people giving out money in the street, if someone were doing it most people would be suspicious. But no one is suspicious of someone doling out free investment advice. Even Warren Buffett, one of the richest men on earth, does not give out free investment advice. One should be always wary of advice doled out on media as good advice is valuable and no one will give out good advice without expecting something in return. We don’t expect money for nothing anywhere else so we should stop expecting “free” advice in stock market as well.
Here are the 5 takeaways for the readers.
Remember: One should remember that there is no free lunch – even in the stock market. Investing is taking a bet on a company’s future performance. Any activity which is a bet on a future event/s will have both uncertainty and risk.
Learn: Investing is about understanding businesses and valuation, it is all about quantifying the businesses opportunities. Even though buying medicines in India is easy it does not mean self-medication is the right thing, it is best to either learn about the disease one is trying to tackle or go to a doctor. Same way even though buying and selling stocks is easy – it does not mean investing without knowledge is the right thing. Investing can be learnt, but one should be ready to put in the time and effort. Investing is a serious business and cannot be treated as the activity for the idle or a venue for entertainment.
Identify the sell parameters before purchasing the stock: It is best to write down the rationale for purchasing and the criteria for exiting a stock before one buys the stock. Criteria for exiting should include the minimum holding period, expected changes in the fundamentals that will lead to value appreciation, explicit criteria about the underlying business that will lead one to sell. Writing down will keep one “honest” and will also create a feedback loop for one to improve and become a better investor.
Plan for mistakes and be skeptical: Investing is an activity which has a significant uncertainty and risk. Even the best investors make mistakes, so the investment strategy should accommodate mistakes so that they don’t lead to debilitating losses. One should always be skeptical of one’s own investment strategy. Skepticism will enable one to critically evaluate the decisions and improve them. One should be especially skeptical of free advice doled out on TV and media.
Remember: Making money is hard, making money by investing is harder, and selling is the hardest part of investing.
by Mr. Praveen Reddy, SEBI certified investment advisor
Disclosure: The author and the clients of IndusWealth own some or all the stocks discussed in this article and may transact in them for their own portfolios.
Disclaimer: Examples cited in the article are for illustrative purposes only. The information provided here is based on our opinions plus our statistical and financial data and independent research. The article does not constitute individual investment advice and is not intended to be a solicitation for investment advisory services. Authors do not guarantee any results that may be obtained from investing in the securities discussed above. Readers should note that investing involves risk and they should not make any investment decision without first consulting his or her own personal financial advisor and conducting his or her own research and due diligence.
About the Author: Praveen Reddy is a SEBI certified investment advisor. He is the founder and Principal advisor in IndusWealth, an Investment advisory firm. He has worked with financial services firms like RBS, Bank of New York Mellon, Credit Suisse First Boston. He has an MBA from IIM Calcutta and a B.Tech from IIT Kharagpur.