When to sell? - Lessons from Philip Fisher XI - Views on News from Equitymaster

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When to sell? - Lessons from Philip Fisher XI

Mar 12, 2013

In our earlier articles in the series on Philip Fisher we focused on the various facts to consider while buying a stock. But, what happens after you have put your hard earned money on the stock? When should you sell your holdings?

Well, according to Mr Fisher there are only three reasons (barring any personal reasons) for which you should sell a stock.

Reason 1: When you made a mistake

In this case, you may have made a mistake in your original purchase and it has becoming increasingly clear that the future of the company you have invested in has become unfavourable. For example, if you had purchased Satyam Computers before Mr Ramalinga Raju admitted to committing a massive fraud. Or SKS Microfinance before the Andhra Pradesh regulation stalled progress in the growing industry. Admitting you are wrong is difficult, but knowing you are wrong and not doing anything about it is foolhardy. Being honest with oneself, not letting ones ego get in the way, and keeping emotions aside are lessons investors should always keep in mind.

If you are disciplined in investing and purchase good quality stocks such mistakes should not happen too often. If mistakes are identified quickly, losses are far smaller than if the same stock were held for a longer time-frame. More importantly, the funds tied up in this undesirable investment can be used more productively. But, however small or large, losses should not be taken lightly. Much like wrong answers on a test, losses should be carefully reviewed so that a lesson is learned from each of them, and the same mistake isn't repeated.

Reason 2: When the reasons you why bought the stock are no longer valid

Let's say you purchased Research in Motion (now Blackberry) because you believed that it would continue to be at the cutting edge of smart phone technology for the next few years. But, then Apple and Samsung come along and quickly garnered market share with their new technology and unique design aesthetic. Now, the reason you purchased the stock is no longer valid and may warrant a revision.

Investors should constantly be on guard and keep track on the affairs of the company whose shares they hold. When the affairs of a company deteriorate it is usually for one of two reasons, either there has been deterioration in the management quality of the company or the company cannot sustain profitability for its product or growth stagnates and shareholder returns diminish. While management deterioration is more deadly, investors should carefully watch out for all these scenarios.

Reason 3: When you believe that you can get better returns in another stock

This third reason should only be practiced by savvy investors who are very sure of their ground. Finding attractive investment opportunities is difficult and purchasing these at the right valuations is all the more challenging. Having surplus liquidity at the time when valuations are attractive is not always the case. If an investor believes that the growth prospect of some other company may be better than the one whose shares he already owns, he may decide to reallocate his funds. Anyway, according to ace investor Peter Lynch, holding too many stocks is not the best idea. He says "Owning stocks is like having children - don't get involved with more than you can handle."

However, with this switching of funds there is also the possibility that some major element in the overall picture may have been overlooked. If this is the case, the new investment needs to be studied more carefully and needs to be given reasonable time (at least 3 years) to deliver.

In conclusion…

Once a stock is properly selected, and has borne the test of time, it's only occasionally that you will find reason to sell the stock. This basic investment principal, unfortunately only seems to be understood by a small minority of successful investors. But if you understand this fundamental principal of long term investing, you can join hands with greats like Warren Buffett, Peter Lynch and Phil Fisher. Investors also shouldn't be scared of potential bear markets or if the value of their stock goes down post purchase. If the company is really a potential star, the next bull market should see the stock making a new peak. Plus, a pure valuation based call may not make sense if the company's earnings are also growing at a fast clip. In this case, telling when exactly the company becomes over priced is difficult as is the case with companies like Page Industries, Mahindra Finance etc. Selling stocks too soon, just because they have seen a huge spurt is another mistake that investors make. Just because it has gone up, doesn't mean that it has lost most of its earning potential. Selling winner and buying stocks that haven't caught the rally may just leave investors holding onto damp squibs.

Fisher concludes his chapter on 'when to sell' with a brilliant quote which we couldn't have put better ourselves. He says "If the job has been done correctly when a common stock is purchased, the time to sell is - almost never."

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