Why Selling is important and difficult at the same time?

Selling- Art and Science 

Shuchi.P.Nahar

When it comes to selling , everyone of us at some point of time had faced some basic questions, like When to sell? How to decide the right time? What is the right price to exit?

And just to have some sense of confidence we ask in our groups , friends ,peers ; 

kya nikal jaaye ? sahi price aagya kya? uppar jaayega yaha se? Kya lagta hei hold kare ya average out ?

something or the other we must have asked or thought before taking the exit .

So here is the article , that will definitely not tell you the exact price to exit the stock but will surely widen the thinking horizon before selling the stock. Its the compilation of  my understanding from various articles that I read past week . Thanks neeraj sir for sharing such valuables. 

Let me start by saying that selling is the hardest thing to do well as an investor. I don’t think anyone does it well consistently, and that includes the whole slew of investing greats past and present  that I’ve studied. Everyone has sold something only to see it rise higher. And everyone has held onto something only to give back lots of apparent gains.

Second, hold onto stocks blindly. Great investors have always written : Advice to buy right and hold on is intended to counter unproductive activity, not to recommend putting them away and forgetting them.

Sometimes, selling half is costly, as you say. Other times, selling half looks smart. 

Selling your stocks at the right time is arguably the most challenging part of trading and it is fraught with emotions!   There are times when we are wrong and we must exit at a loss – that is hard!  There are times when we buy strong stocks that perform very well, We tend to sell these too early because we doubt that the strength can last.

Then there is the pain of watching a winning trade turn into a loser because we fail to exit at all!

Winner and Wolf sum up:

“These proactive portfolio adjustments do not represent a change in fund management’s fundamental approach to analyzing businesses and the prices of their securities, nor does it mean that we are now engaged in ‘market timing.’ We time our entry and exit from securities positions based upon fundamental valuations, not on expectations of price movements in the market.”

In the end, what you want to do is go in as a buy-and-hold investor. You want the effects of compounding to work for you, as well as the favorable tax treatment that goes along with buy-and-hold. So I think it is important to enter every new investment with a buy-and-hold mentality. Even modest rates of return pile up to extraordinary heights over time. But you also want to be alert to when your thesis is no longer true.

When the main thesis for owning the stock vanishes, it’s often a good time to go. If a great balance sheet is one of the reasons you own something, for example, and it does a deal that makes the balance sheet weak, then it’s time to go. Or if you bought a stock because of a big gap between the stock price and NAV and that gap closes, then it’s time to at least think about selling. This is probably my favorite reason to sell. 

The bottom line: There is no magic way to sell to ensure maximum gains every time out. 

I think anytime you sell, you could cost yourself money if that stock turns out to be a big winner. I understand that risk. On the other hand, as Third Avenue shows, there are also risks in getting too complacent about a holding. When the market gives you a great price to sell, you should be willing to at least think about reducing your position. As long as valuations remain reasonable, though, you may hold a stock indefinitely as the stock and the value of the business grow together over time.

Fundamental Exits: Pros & Cons

Let’s define a fundamental approach to selling as exiting a trade when the stock’s price is greater than its fundamental value. Put that up against the technical approach.   Selling a stock when there is a signal from its trading activity that the stock is more likely to go lower than higher.

While the notion that we should sell a stock if its price is higher than its fundamental value makes a lot of sense, there are major problems in its application.

Should you sell when the stock is overpriced? We are operating in one of the world’s most rapidly growing economies and businesses are nowhere close to saturation. For us, a 5% or 6% growth is a slowdown. We have a lot of growth to see and our businesses have very long runways of future growth ahead. Businesses that can deliver growth without stretching balance sheets and without taking in more capital (through the issuance of new equity shares) and where the quality of growth is excellent in terms of incremental returns on capital—they will increase per share value for stock holders over the long term. 

That potential growth in value is sometimes mispriced by markets even if the stock has appreciated a lot already. Under those circumstances, it would be a mistake to sell. You shouldn’t look at how much money you’ve made, but look at the potential value of the business 10 or 15 years down the road and then take a decision. 

Do not focus on the stock price but on performance of the underlying business. As Warren Buffet says, focus on the playing field, not the scoreboard. Too many investors look at the score board; they tend to focus on the current stock price, the current P/E multiple or the percentage gain in the stock price in relation to the gains in some index or some other stocks.

Sell Signal: P&L Based Exit

Other people sell when a stock drops below their predetermined risk level. Meaning they say I don’t want to lose more than X% on this stock from entry to exit and then raise the stop as the stock rallies.

Trailing stops can be used and adjusted for any of these strategies.

There are many other sell signals but this is just an intro to some of the most common.

This approach is not without its faults. The most common mistake that traders make is taking a too short-term view for the trading style that they are applying. If you are a longer term trader looking for entry signals on a daily chart then you should not be looking for trend line breaks on an intraday chart. It is probably best to look for a longer term entry signal using a weekly chart.

As good traders say, the profit is in the patience.

While remaining disciplined in terms of the process of stock-picking, the seasoned value investor waits patiently for Mr. Market to provide opportunity. Typically, there are just four reasons to sell:

• A clear deterioration in either earning power or ‘asset’ value.
• Market price exceeds ‘fair’ value by a meaningful margin.
• The primary assumptions, or expected catalysts, identified prior to making the investment are unlikely to materialise or are proven to be flawed.
• An opportunity likely to yield superior returns (with a high degree of certainty) as compared to the least attractive current holdings is on offer.

Now that the selling compass is pointing in the right direction, perhaps one needs to come to grips with the tribulations of putting these simple ideas into practice. 

The longer I think about why this plagues even expert investors, the more I am struck by the fact that ‘selling smart’ is the dark continent of investing. Just to set the record straight, can you think of more than a couple of books with worthwhile insights on ‘how to sell’ as opposed to the countless investment bestsellers on every other conceivable topic of relevance? 

Should you sell because another stock looks better? If something is working for you, and you don’t have cash and if something else turns up and you like it a lot, then you should sell what’s working for you only when what you want to buy will give you a significantly higher expected return. Otherwise, just hold on to your great businesses and let them compound your capital for you.

So what can we do to avoid costly and annoying errors?

• Approach investment decisions from as neutral a position as possible
• Ignore all sunk costs by ignoring the cost of the investment when reviewing your portfolio
• Accept it as inevitable that you will make mistakes in your buying decisions
• You will face tremendous pressure that will tempt you to rationalize your mistakes and not correct them
• You will tend to protect the status quo by inventing new reasons to hold on to a bad investment
  • This will be especially true when your original buying decision is known to many other people who are important to you, as it will hurt you to acknowledge this to them, and to yourself.
  • It will be difficult for you to correct the mistake because you will attach more importance to saving face by appearing to be consistent with your past commitments.
• Don’t overvalue your current positions. Pretend that you don’t own them, and ask, “If I didn’t own this stock today, would I buy it?” If the answer is no, you should think hard about selling.
• Don’t compound past mistakes for fear of embarrassment. In the end, the best advice is to learn from mistakes and move on.

Typically, the small profits arising from good luck rather than skill are swiftly pocketed, but whenever a paper loss is sustained the normal investor accounts for it as a ‘long-term investment’ and eventually the lack of skill overwhelms the mis-classification. A third, trickier, phenomenon occurs when a stock rises smartly and then slips into a gradual, but steady decline. In this instance, the issue is a loss of profits! 

This fall causes far less pain, but is just as negative. Two simple rules come to mind. First, what works for me personally, after years of coping with unremitting losses is to sell out completely whenever a new investment shrinks by more than 15 percent. Not only does this deal with my dumber prejudices and blind spots in a ruthlessly efficient manner, more importantly it frees capital. With ‘dead money’ it is probably best to sell one-third, maybe even half the holding rather than the entire position simply because such stocks occasionally experience incredibly short, sharp rebounds. That is probably the moment to get rid of the rest! 

When you are carrying out a portfolio review, resist the temptation to sell the stocks with the best profits. Instead, relentlessly focus on selling the companies which meet the BBBB test — bent, broken or beyond belief!

The decision to sell is complicated. One needs the right dosage of detachment, but then one also needs to be very much attached to the right kinds of businesses and people who run them. The first thing to ask is whether the business is delivering what you envisaged. By and large, is the business is delivering performance in line with your long-term projections? Some slippages must be tolerated. 

Some mis-allocation of capital decisions must be tolerated. It’s important to not measure this performance every quarter. Just because the information is available, you don’t have to use it. Imagine if companies were required to provide monthly performance, not just quarterly. How important would those numbers be? More data does not result in more insights. Often, it results in bad judgments. Equally important is to determine whether or not that performance is coming from variables envisaged and not some other factor. 

If the answer to that is overwhelmingly yes, then you could get pleasantly surprised as great businesses tend to do better than earlier envisaged. So, to help determine if you should hold or sell a business that’s really working for you, use what I call as blue sky scenario. Basically, it means that you should not use the same assumptions you used when you bought the stock. This is especially true when the business you bought into is doing far better than you had anticipated. 

If you bought the right type of business, then there is likely to be tendency for it to deliver better than what you envisaged. If you see that tendency play out after you have invested, don’t ruin it by staying with the original model. Your model has to be adaptive. If the performance is far better (or worse) than you envisaged, you have to change the model unless the improvement (or deterioration is likely to be temporary).

Is investing in equities only about buying good stocks? Let us recall some blockbusters of yesteryears— Jubilant Foods, Just Dial, DLF, Wockhardt, Financial Technologies, BHEL, SAIL, GMR, Kingfisher, Idea, Airtel and Satyam. Not only Indian companies, let us also recall some global bluechips such as Kodak, Blackberry and Nokia. How have these stocks performed in recent years?

Their price performances have not been up to the mark. In fact, most of them have under performed for several years

 Their price performances have not been up to the mark. In fact, most of them have under performed for several years. The lesson is simple: while buying good stocks is certainly a critical part of investing, taking exit calls at the opportune time is also important.

When and how does one take an exit call?

If we look at the above and some other under performing examples, a number of scenarios emerge when one has to take an exit call. The erosion of cash flow visibility is is one of the prime reasons for the under performance of any business. If the business conditions change and the business is not able to generate cash flows in an expected time frame, then it would be very difficult to get returns from such business models. 

In the Indian context, over the past few years, some of the companies that own infrastructure assets have fallen in this category resulting in a sharp under performance.

My Key Takeaways

•The best sell decision is the one which you have thought at the time of buying that stock.

•When your own original hypothesis no longer hold true. The position is breaking your allocation rules.

•There is a change in management , and you are not comfortable with.

•Promises v/s delivery

•Cash calls due to market , sell % of all holding

•Business has undergone a huge change.

•When you have something in your portfolio and it doesn’t work as you thought for 1 year then sell.

        Many of you must be thinking that how can selling be Science ? So answer to your doubt is anything that follows a process backed by theory is called as science. We all know the answer for Why selling is an Art but hardly we conclude that Selling is an Art and Science both together. If we understand the depth selling requires a right procedure to be followed every time. Selling requires your thesis and every new experiment brings out the new rule.

Sources: kiplinger

                ForbesIndia

                Stallwart Advisors

                Seeking Alpha

               Economic Times

               ChartyourTrade

               Morning Star

               Oldschoolvalue

Disclaimer: I’ve tried to note down my key learning from all the publicly available reports.

This is just a compilation of few thoughts that I picked up. The above mentioned sources have in detailed articles that i have summarized here. They are great reads to dwell deep into the topics.

                                       Shuchi.P.Nahar