When to sell ?

I recently received a comment from rajiv which is reproduced below

Rohit,
As a stock moves towards its intrinsic value, there is a temptation to exit a little before the final value is hit, especially if you have waited a long time for Mr. Market to come around.
I feel that as a value investor the sell decision is much tougher than the buy decision, because the buy decision usually comes with a big enough margin of safety. However, during the sale decision the market value may be stuck at Intrinsic Value minus 10%, making the investor quite jittery to sell.

I have been asked this question in a several different ways, but all essentially boil down to the point – when should one sell a stock ?

I agree with the point made by rajiv and several other readers – selling is more diffcult than buying. In addition, there is no clear cut formulae for selling. The process of selling is made even more diffcult by the various emotional and psychological factors involved in selling.

Emotional factors
Most the discussions and articles on investing rarely discuss emotions explicitly. I find that strange as anyone who has ever invested in the market can vouch for the emotional roller coaster. The rational aspect of selling is easy for a long term investor – sell when price crosses intrinsic value (or 10% below or above – take your pick of the number)

I have written on the above question earlier – see here. The is the rational way of deciding on when to sell.

Now this suggestion may have sounded irritating to some of you and rightly so. The reason this advice, though rational, does not sound great is due to the emotions involved in selling.

There are two situations in which one is selling – one has made great gains in the stock and wants to capture some of the gains. Selling at this point is driven by the fear of losing the gain, which is counterbalanced by the desire to hold on to a stock which has treated you well and also by the doubt that there may be more upside to it.

The other situation in which one sells a stock is when one has lost money on the stock and wants to get rid of that piece of !!@##. In this situation the decision is driven by disgust.

These emotions are quite powerful and not easy to manage

Ok, dude then what?
All these emotions are nothing new, right ? Even if you have felt these emotions earlier, it does not mean that you are managing them well.

A few of the readers and my friends have mentioned to me that I seem rational and cool headed. I wish !!. I am no different, atleast in most aspects. In case of investing, I have tried to manage my emotions as much as I can (manage and not master).

I maintain a spreadsheet of all my holding with the qty, intrinsic value estimate, current price and discount to the current price. At any point of time, when I am looking at my holding, I am looking at the instrinsic value and the discount to it. I ‘anchor’ myself to the instrinsic value. As a result if the stock is selling below the intrinsic value, I will continue to hold.

As the intrinsic value of the stock gets updated every quarter, I am not tied to a fixed value. If the business performs well, the intrinsic value goes up and so does the sell target. If the company performs badly, then the reverse happens.

So is this buy and hold ?
Buy and hold is most abused and misunderstood term (more on that in another post). My approach is not buy and hold, tops and bottom or any other term or title. The logic is simple – buy when something sells for less than intrinsic value, hold till it is below intrinsic value and sell when it is above it. Now if the intrinsic value grows faster than the price, I will continue to hold.

Where’s the catch ?
The catch is in getting the fundamentals and intrinsic value estimate wrong. If you get that wrong and refuse to change your opinion, then you are toast.

But you lose money when the market drops !!
Yes, that does happen. If the market drops, my portfolio will drop with the market. I have yet to figure out how to keep jumping in and out of stocks and still keep my sanity. There is so much chatter and noise in the market, that it is easy to go nuts. My way of keeping my sanity intact, has been to adopt the above approach.

Is this the best way ? no I will not claim that. However as I have a day job, I would rather lose a percentage points, than lose my job and maybe my sanity. Finally, I have yet to find another approach which relies on a sensible and consistent logic and not on the opinion of others.