When to Sell a Stock? Use these Two Guiding Principles

Since no one can time the market, knowing when to sell is one of the toughest decisions an investor is called upon to make. Our emotions complicate the decision even more.  If your stock price is up, greed and/or ego usually takes over, and you want an even higher price. If the stock is below your buy-price, you start fearing it will fall further; you will then want to sell and get out. You need to prevent your emotions from dictating your decisions. And for that, you need to know the right time to sell a stock and the right price to sell it at.

MoneyWorks4me uses the MRP-the Fair Price of a stock as an anchor to take buying and selling decisions. We buy below MRP after applying a Margin of Safety, the MOS, as a reasonable discount. We prefer to buy wonderful businesses and hold on to them for a long time.  But change occurs at various levels: the company, the sector, the economy, global developments that impact the performance of a company and finally the continual fluctuations in market price. So, you need some guiding principles about when to sell.

Guiding Principle No 1: When a  company doesn't seem to be a wonderful business ...

When a  company doesn’t seem to be the wonderful business you thought it was, you should decide to exit or reduce your holding. Examine the data you have that convinced you about this. Whether you wait for a good price to sell or not depends on what has led to the changed status. Remember, you bought on the basis of the data and information you had, and when you find new data that tells you otherwise, it is prudent to act on it and not deny or discredit the data. In some cases, you may have to sell it at a loss, but it’s better to bite the bullet early.

Guiding Principle No 2: When the market price has run up very high ...

When the market price has run up so high that the stock will give poor/low returns over the next few years, then you should consider booking some profits. We know that in the long run the market will act as a weighing machine, and the price will be more aligned to the company’s fundamentals. So, if a stock’s price has already gone up way above its Fair Price now, then holding on to the stock means you run the risk of low returns going forward, and also of some event happening that leads to a price correction. It is prudent to sell and book some/all the profit and reinvest in something that will give higher risk-adjusted returns.

MoneyWorks4me assesses the Premium over the Fair Price to recommend sensible sell decisions

Just as we insist on a different MOS for different companies when buying, at Moneyworks4me we put a ‘Premium’ on the MRP before selling. So, if the current market price is higher than the premium fixed for the company stock, we consider selling a portion of our holding. If the premium increases further, we are comfortable with selling a larger portion of our holding. We do not recommend selling in one go, but to do it in tranches as explained in 'How a process for buying and selling can help reduce remorse and make you a better investor?’ This system of selling stock in tranches depending on the Premium helps us take logical sell decisions. It ensures healthy returns, avoids premature selling and books profits sensibly.

MoneyWorks4me calculates a rational premium in such a manner that it factors in the future expected growth over a certain number of years depending on the quality of stock. In essence, we prefer to hold on to good/wonderful businesses. However, when the prices of some stocks soar to irrational heights, we think it is prudent to book profits and invest in other opportunities to earn high risk-adjusted returns.