June 10, 2009

Should I sell ?

I have been receiving this question and its variants via comments and emails for the last few days.

Let me try to answer this question from my point of view. My response may not be typical of what is usually recommended and may not suit your specific case.

I am wary of a simplistic approach of selling stocks at an X % profit or at predefined index or price level. A decision to sell, like buying is more nuanced and requires more thought than that.

Two criterias for selling
In my case, the selling criteria is part and parcel of the analysis done before buying the stock. I typically will have an exit criteria in mind based on fundamentals and valuation at the time of buying the stock. If the business fundamentals deteriorate more than expected (see
my post on India nippon), then I will sell the stock if I think that the drop is not temporary and the intrinsic value will stagnate or drop in the future.

The second case where i sell the stock is when the current price exceeds the intrinsic value by 10-15% and the future increases in the intrinsic value is less than the returns I can get via other opportunities. So if the stock is selling at intrinsic value and I can find another idea at a 40% or higher discount, then I will sell the stock and re-invest the proceeds in the new idea.

You will notice a lack of reference to any pre-determined index levels or fixed increase in stock price in my sell criteria. For starters, index levels do not have a direct bearing on individual stock. My pick can stagnate when the index is rising and vice versa. So selling a stock just because the index has gone up would be foolish

Mental accounting
I will also not sell stock just because it has gone up by X% to ‘book’ some profit and leave my profits behind. This would be a clear case of mental accounting (put cost and profit in different mental accounts) and an attempt to avoid regret. If one breaks the investment into different mental accounts, there is tendency to recover the cost and let the profit run. I see no reason to treat profits any different from the cost. The entire money is just one single account (available capital) and it is important to take decision on the entire holding as such.

Avoiding regret
A common reason for selling is also to avoid regret. If the market drops, I will regret losing the profit. However I would say that in the short term, it is impossible to avoid regret. If the market rises, then you will end up regretting selling the stock and losing on the upside.

If I cannot predict the markets and avoid regret, the best option is to have an approach based on intrinsic value and accept the fact that I could face regret in the short term irrespective of my decision. The same scenario occurred for anyone who waited for the election results to commence buying. In order to avoid the regret of buying at a higher price and then see the price drop after the elections, they ended up watching the price shoot up and are now regretting missing the rise.

Final bias – hindsight bias
The silliest reason by far is to evaluate a decision based on how the market moves in the short term. If the market rises after I decide to hold the stock, does it make me smart or stupid if the market drops? absolutely not !!

All investing decisions have to be taken based on current information and in absence of knowing which way the market will move, my decision can appear to be very smart or stupid in the short run. However if you follow a rational approach of buying and selling stocks based on some measure of value, then short term market movements should not trouble you too much (which ofcourse is easier said than done)

19 comments:

ravi said...

Hi Rohit,
I hope you read this rather long comment of mine. You seem to explain the noise that I constantly have in my mind at any point of time. Now that you have posted this, I have a couple of questions.
When it comes to personal investments, do you book losses when you know that its a dud investment, especially when you are not short on investible surplus funds. Even I hold india nippon but at a higher price but I am not ready to sell it as I have surplus funds which I am waiting for an oppurtunity to invest. My second question is about the sell price decision based on your post. Let us take one hypothetical example. Let us say that the market values All your stocks in portfolio are qouting well above 15% of your estimated intrinsic value. Would you have the conviction to sell the entire portfolio and sit on cash waiting for the next opportunity. Please do not mistake me. I feel as if I am questioning myself. I hope I will get a honest opinion of yours on this. I have always felt that you blog about the stocks that I have selected for investment or already invested. While I also easily advice my friends on the right things to do, its difficult for me to take losses. I think its human tendency. Yes, I agree that when you do not have surplus money and there is a great oppuortunity, its better to book those losses and deploy that money. But when it comes to application, do you sell something that is at a loss of capital and then invest that or do you sell something that you have either broke even or at a very meager profit even though you know the dud stock is the one that should be sold?

Manish Chauhan said...

I can relate all these to Trading too . One of the most difficult situation faced by me or any other trader is "avoid regreting" Selling or buying . Thats purely emotional .

But the issue with Trading (short term) unlike Value investing is that you can do buying and selling based on Intrinsic value .

Manish
http://www.jagoinvestor.com

Anonymous said...

thanks Rohit,
This helped me to exit today from couple of scrips where price exceeded Intrinsic value..i.e. more than 100% returns.

Still I have some good scrips like Balmer, tata Investment Corp, Thermax, Mercator lines where Price is 10% more than Intrinsic value and i have no courage to come out..

Ani

karthik said...

Hi Rohit,

Well said!! I currently hold X MF but it has been underperforming for the past 3 years. Now I find another fund which has been doing very well for the past 5 yrs ( I checked the usual stuff like performance,ranking,rations,credibilty e.t.c). Iam also paying 2.25 % brokerage as it was suggested by a financial consultant couple of years back.I conclude that the new fund (Y) is better than fund I have invested (X).
Now the question is
1.Should I accept that I had made a mistake in the first place and switch.. Then Should I redeem the full amount and pay in the new fund (one time)... But then I will be investing when the market is high.
2. But I usually do a SIP..Would I not be wasting my chance of compounding if I remove everythig from the invested fund?
3. Is there a way to invest only the further SIP amount but hold the amount already invested in the old fund house and let it compound?

Sorry for the long post but Iam not able to decide whether Iam making a rational decision by switching. Anyways The fund I have already invested is HSBC equity and the new fund is DSP top 200 equity.

Anonymous said...

Absolutely.
Its hard to hold your emotions back and stick to your decision when market is going up and still holding the stock.
Once you can follow this,I think that is having REALLY strong mind.

Avadhut

Anonymous said...

In one of the partnership letter, buffet explains two of his work outs..one is Commonwealth Trust and other is Sanborn Map. we can see in initial days how buffet had concentrated portfolio..Commonwealth trust was allocated 20% capital and sanborn map 35%. Also he mentions about buying price and selling price.. For example he bought Commonwealth trust on avg $51 per share and sold at the year end at $80..since his position was of 20% of total fund, returns were huge.. and in initial days Buffet executed many work outs like this.. to increase his capital base.

So Question is can we do the same? can we sell our holdings if we are getting sufficient results?

Ani

Rohit Chauhan said...

Hi ravi
those are great questions and let me answer on what i have done in the past (we all know what we should do, but we are not always rational)

i am completely with you on the diffculty of selling. actually selling is far more diffcult than buying.

in my case, my equity allocation is not high as a total % of capital and hence i usually have surplus cash with me. so i am in the same position as you. i have engaged in the same exercise of holding on to a stock even if it was dud till i can find a replacement.

however now i am trying change my thinking. all money is equal ..doesnt matter if it is cash or held in a stock ..its a question of future return. so a rational option would be to see if the likely returns on the stock will exceed that of holding cash. however there is another hidden bais ..if you already hold a stock..you will tend to look at it more favorably. to avoid these mental biases, i have forced myself in the past to sell duds even if they were no immediate options to deploy cash.

in addition, i try to avoid looking at the gain or loss i have already made. it is immaterail in terms of future returns. as i said in the post, i will look at if i am right ..if not i will sell. else if the price is near intrinsic value ..i will sell even if i cannot deploy the cash immediately. i have done that in the past (2006-2007) and plan to do it in the future.

ofcourse you will stupid when you sell, and the market runs away beyond intrinsic value ..but i try to be disciplined and not get too disturbed by how i feel

hopefully my reply answers your question

regards
rohit

Rohit Chauhan said...

Hi manish
emotions and biases are same ..irrespective of which investing philosohy one follows

regards
rohit

Rohit Chauhan said...

Hi karthik
the thing with mutual funds is that they are very different from stock in terms of future performance.
there is no assurance that the fund which was doing well will continue to do so and vice versa. i would suggest you try to understand why the fund in question is doing badly and why the other one is doing well
if however you make up your mind ..then its better to move completely rather than doing a mix of stuff. invested money or cash is all the same. does not matter if the cash is in the account or invested in the fund as of now. i would recommend making a decision based on which mutual fund you are more confident about and not based on what is already invested and trying to recover that amount

Rohit Chauhan said...

hi avadhut
more than strong mind, if you know yourself, the effort has to be to be rational and logical.ofcourse its easier said than done
regards
rohit

Rohit Chauhan said...

hi ani
to both of your comments - buffett sold companies at or lower than intrinsic value and bought even cheaper stocks. so he actively sold fully or slighlty cheap stocks to invest in cheaper stocks yet.
this approach worked for him with a small amount of capital and gives higher returns.
this will work for us too ..but the key point as i noted in the post is that you would sell a stock at or below intrisinc value to buy something which is even cheaper. that can give even higher returns ..the challenge is ofcourse finding cheaper stocks than the one you hold.

i personally would like to follow this approach but not able to do much due to time constraints. with a day job it is diffcult to do this extensively

regards
rohit

ravi said...

Thanks Rohit. I think you have answered all my questions. Specially I luv your comment which sums it all 'we all know what we should do, but we are not always rational'. Very true specially when there is attachment. I am trying to get disciplined but I have to overcome my resistance to book losses. The way I use to get convinced is that what would I do with the cash once I book as I am already waiting with surplus funds. Now I understand that I have to force myself to do it for sometime until it becomes a natural habit to do so. You are doing a awesome job. Keep it up.
Regards
Ravi

Rohit Chauhan said...

Hi ravi
it is always painful to accept a loss or a even worse a mistake. the only thing one can do is to learn from it and not compound it by not recognizing it

regards
rohit

Rathin Shah said...

Hi Rohit,

Just wanted to ask one question regarding Annual reports. Can you let us know the process of going through the whole annual report. How do you go about reading it. Do you start with the MD&A, or initially read the balance sheet /financial statements / footnotes. For the investor it is mandatory to read the annual report for making sound investments. But then there are somethings mentioned like meetings, committees etc. which I guess have no use (may be I am wrong). So what should we leave when we read the annual report. And while doing the FS analysis, what are the priority items. Also let us know about the standalone and the consolidated nos. I just had read about Pantaloon's AR last year. It had consolidated loss but standalone profits, so which number should we use for calculating P/E's etc.

During the recent run up in the prices some companies appeared cheap (by standards like PE, PB Div yield) when I did filters on the financial websites. So should we analyze all these companies Annual reports. If that's the case, prices just went up ( I am not indicating that we miss the boat). So what should we do during those times. Should we skip reading annual reports. (this might relate to Graham's bargain stocks too).

Please address the issue when u do have time. I am really hopeful of getting your sound advice.

Thanks and regards,
Rathin

Anonymous said...

Hi rohit,

Can you please suggest some stock screening websites (free ofcourse) to perform some screening?

Thanks

Rohit Chauhan said...

Hi rathin

Let me answer your question via post. you may want to read this post for my process on analysing stocks

http://valueinvestorindia.blogspot.com/2008/08/how-i-analyse-stocks.html

Rohit Chauhan said...

hi anonymous
i generally use icici direct for my intial screening and to get the data. after that i use my own spreadsheet to refine the list further

regards
rohit

Anonymous said...

Balmer & Lawrie posted good results & declared nice dividend of Rs.20.

What is your new IV for BLL, Rohit?

Regards
Ani

Rohit Chauhan said...

Hi ani
i saw the results and am fairly impressed. the result quality has improved a lot in the last quarter. so although the topline is down, the bottom line is up and company is doing well.
interestingly my 'guess' on the PBIT no. in the spreadsheet is fairly close :)
i would bump up the IV by around 10%. overall fairly good results considering the economy ..cant ask for more

regards
rohit