Most often we face a challenge of when to sell a stock. Well this might be the most difficult question of the all in a stock market and it is also very true that it can not have a straight forward answer. So here I would like to describe this in my own way of explaining few questions that comes various times to various people's mind. But before going into that let me tell you selling point is more of strategical point rather than an emotional point hence we have to plan our selling strategy even before we buy a stock. Now let me explain how..
1. Set your timeline first :- While buying a stock you must need to set a timeline for that stock i.e. how long you are going to hold it?
2. Set an expected return from this stock for this time period :- Now set a %return attached to your investment and have an alert when it reaches that price level. ET Portfolio Alert feature can really be helpful in this regards.
3. What to do when it reaches that level ? :- Well this might be a million dollar question comes to your mind that when this alert level reach what will you do? To explain this first you need to understand how to set this alert ? Well it's not an any arbitrary % return that you set on your portfolio rather it should be determined by an particular method you follow for your investment. Let's take an example of my own method which I call retrospective periodic analysis :-
3.1. First you need to calculate the intrinsic value of the stock :- [How I calculate it, has been explained in Calculating Intrinsic Value section] Now for that I have to consider few things like it's revenue, revenue growth rate, current PE,Forward PE and discounting rate based on the risk and opportunity in it's business model. Generally this model has been created on yearly purpose but for periodic analysis I create it for Quarterly purpose as well having 12 quarter i.e. 3 years in the perspective and for yearly analysis I create it for 10 year.
3.2. Periodic analysis of this value :- Now we have to compare whether the revenue growth rate is better than our estimation of less than it?
3.2.1. In case it is better than our estimate then we have to adjust our expected growth rate and re calculate the value and need to also change current PE and Forward PE value as well. Now if we find that it has already reached the Forward PE estimated value for the 3 year then we should sale it of otherwise we must hold on to it for more return.
3.2.2. In case it is lower than our estimate then we have to adjust our expected growth rate and re calculate the value and need to also change current PE and Forward PE value as well. Now if we find that it has already reached the Forward PE estimated value for the 3 year then we should sale it of otherwise we must hold on to it for more return.
3.2.3. Though this decision is not that straight forward. You also need to check if the company is able to maintain it's PAT and EPS growth rate as well or not. In case if PAT decline and it's due to a temporary cause [e.g. Capex expansion, Investment , Short term inventory loss, Tax rate etc ] then you still can hold it but if it is due to less demand and sales growth suffer or some law suit or some approval goes against it then you must sell it off.
4. What if my target price does not reach and ? Well in case your target price does not reach you also need to follow the above mentioned process [3.2.2] and take the decision accordingly.
5. What if I am loosing ? Well that is a very critical question that every investors perhaps faced even novice to Mr. Warren Buffett [who is still making loss on his big investment of IBM for 3 consecutive year which he has bought on Nov 2011 till today which is Jan 2015] . So I guess you can understand if Mr. Buffett failed to analyze it then quite obviously with our very less knowledge we too fail. Now the question arises
5.1. Should we hold on to it or not ? To explain this let me tell you the cost attached to it.
5.1.1. It might have a downward risk or trend in near term so that you might loose more money than what you are loosing now. To analyze this you have to identify few things :-
a. Why it's profit or revenue is down ?
b. Whether the company is taking some serious steps to overcome this or not like change in business model shift from concentration to diversification or targeting other profitable segment and whether the company has enough ability to overcome this or not?
c. If demand for the product is sustainable and growing or not?
5.1.2. It might have a high opportunity cost. Now that is a very critical aspect of this investment like if we hold onto a loss making business for long we might miss various opportunity the current market is offering. So in my opinion it is wise to sell of a loss making investment if you have find out a new one which has a strong potential to grow. But taking this decision is not so easy as it sound because as per human psychology it's hurt us much more if we loose 1-2% of our money rather than missing a 15-20% profit making opportunity. But to be honest this is a very wrong emotion we play with and to avoid this trap we must not invest bulk of our money in one company so that it hurt us more when comes to getting out of it. Because turning around a loss making business to a profit making one is not an easy or one day job it takes time doesn't matter how good the management are and also it always have risk involved in it of not return to it's previous status at all. So with due respect to Mr. Buffett I am a strong believer of selling of loos making unit and buy a profitable one.
5.2. At what price we should sell it ? Well this follow the same format of my previously explained section 3.2.2 and 3.2.3. It we find price is higher than this then we always should sell it also as risk involved in this you should raise the discounting rate and margin of safety to stretched level while calculating the value.
1. Set your timeline first :- While buying a stock you must need to set a timeline for that stock i.e. how long you are going to hold it?
2. Set an expected return from this stock for this time period :- Now set a %return attached to your investment and have an alert when it reaches that price level. ET Portfolio Alert feature can really be helpful in this regards.
3. What to do when it reaches that level ? :- Well this might be a million dollar question comes to your mind that when this alert level reach what will you do? To explain this first you need to understand how to set this alert ? Well it's not an any arbitrary % return that you set on your portfolio rather it should be determined by an particular method you follow for your investment. Let's take an example of my own method which I call retrospective periodic analysis :-
3.1. First you need to calculate the intrinsic value of the stock :- [How I calculate it, has been explained in Calculating Intrinsic Value section] Now for that I have to consider few things like it's revenue, revenue growth rate, current PE,Forward PE and discounting rate based on the risk and opportunity in it's business model. Generally this model has been created on yearly purpose but for periodic analysis I create it for Quarterly purpose as well having 12 quarter i.e. 3 years in the perspective and for yearly analysis I create it for 10 year.
3.2. Periodic analysis of this value :- Now we have to compare whether the revenue growth rate is better than our estimation of less than it?
3.2.1. In case it is better than our estimate then we have to adjust our expected growth rate and re calculate the value and need to also change current PE and Forward PE value as well. Now if we find that it has already reached the Forward PE estimated value for the 3 year then we should sale it of otherwise we must hold on to it for more return.
3.2.2. In case it is lower than our estimate then we have to adjust our expected growth rate and re calculate the value and need to also change current PE and Forward PE value as well. Now if we find that it has already reached the Forward PE estimated value for the 3 year then we should sale it of otherwise we must hold on to it for more return.
3.2.3. Though this decision is not that straight forward. You also need to check if the company is able to maintain it's PAT and EPS growth rate as well or not. In case if PAT decline and it's due to a temporary cause [e.g. Capex expansion, Investment , Short term inventory loss, Tax rate etc ] then you still can hold it but if it is due to less demand and sales growth suffer or some law suit or some approval goes against it then you must sell it off.
4. What if my target price does not reach and ? Well in case your target price does not reach you also need to follow the above mentioned process [3.2.2] and take the decision accordingly.
5. What if I am loosing ? Well that is a very critical question that every investors perhaps faced even novice to Mr. Warren Buffett [who is still making loss on his big investment of IBM for 3 consecutive year which he has bought on Nov 2011 till today which is Jan 2015] . So I guess you can understand if Mr. Buffett failed to analyze it then quite obviously with our very less knowledge we too fail. Now the question arises
5.1. Should we hold on to it or not ? To explain this let me tell you the cost attached to it.
5.1.1. It might have a downward risk or trend in near term so that you might loose more money than what you are loosing now. To analyze this you have to identify few things :-
a. Why it's profit or revenue is down ?
b. Whether the company is taking some serious steps to overcome this or not like change in business model shift from concentration to diversification or targeting other profitable segment and whether the company has enough ability to overcome this or not?
c. If demand for the product is sustainable and growing or not?
5.1.2. It might have a high opportunity cost. Now that is a very critical aspect of this investment like if we hold onto a loss making business for long we might miss various opportunity the current market is offering. So in my opinion it is wise to sell of a loss making investment if you have find out a new one which has a strong potential to grow. But taking this decision is not so easy as it sound because as per human psychology it's hurt us much more if we loose 1-2% of our money rather than missing a 15-20% profit making opportunity. But to be honest this is a very wrong emotion we play with and to avoid this trap we must not invest bulk of our money in one company so that it hurt us more when comes to getting out of it. Because turning around a loss making business to a profit making one is not an easy or one day job it takes time doesn't matter how good the management are and also it always have risk involved in it of not return to it's previous status at all. So with due respect to Mr. Buffett I am a strong believer of selling of loos making unit and buy a profitable one.
5.2. At what price we should sell it ? Well this follow the same format of my previously explained section 3.2.2 and 3.2.3. It we find price is higher than this then we always should sell it also as risk involved in this you should raise the discounting rate and margin of safety to stretched level while calculating the value.
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