10 Reasons for Selling
During your investing career, you will do these two
transactions; buying and selling. Buying requires knowing the
fair value of a stock and then compare it with recent price. If
recent stock price is 10% below fair value and an investor does
not mind getting a 10% return, then he should buy the stock. If
not, he can then move on to other stocks.
Selling, however is not that simple. Sometimes, investment do
not go the way you want it to be. Your prediction may not be
accurate. Furthermore, your time frame may be longer than you
expected. Here are ten different reasons investors might sell a
common stock:
Need the money. This generally happens due to improper
planning. However, things happen. Even the most carefully
planned strategy may not work. Catastrophic events such as
Hurricane Katrina or Rita may force investors to sell an
investment if his household is affected by it.
The book is unclean. When management left their post
abruptly or when the Securities of Exchange Commission (SEC)
conduct a criminal investigation on a company, it may be time to
sell. Your assumption may be inaccurate as a lot of fair value
calculation is based on the company's balance sheet, cash flow
or other financial statement published by management.
Takeover news. When one of your stock holding is getting
bought by other companies, it may be time to sell. Sure, you
might like the acquiring company but you still need to figure
out the fair value of the common stock of the acquiring company.
If the acquiring company is overvalued, then it is best to sell.
A good example would be the purchase of Time Warner by American
Online (AOL) in 2000. At the time, AOL share price was way
overvalued with Price Earning ratio of 100.
Taking Profits Off the Table. Your stock has risen 40%
from your purchase price. Your fair value calculation indicates
that the stock can rise 10% more. Should you sell? Sure. After
all, the goal of every investor is to make money. If you feel
that you need to get something off the table, then by all means
do it. I am not going to be naive and assume that you should
wait for the stock price to rise 10% more. Remember that stock
price goes up and down and that fair value calculation has some
degree of uncertainty. Would you risk your 40% gain for an
additional 10% return? I probably wouldn't.
Other Investment Opportunity. Let's say you bought stock
A and it has risen to 10% below its fair value. Meanwhile, you
had watched stock B fallen to below 50% of your calculated fair
value. This is an easy decision. Go Ahead! Sell your stock A and
buy stock B. Our goal as an investor is to maximize our
investment return. Sacrificing a 10% of return in order to earn
a 50% return is a sensible way to do that.
Inaccurate Fair Value Calculation. Let's face it. People
make mistakes. As investors, we sometimes made errors in our
fair value calculation. There are factors that we might not take
into accounts when researching a particular company. For
example, Merck & Co Inc. will have a higher fair value if we
dismiss the potential Vioxx liability that some say to be as
high as $ 50 Billion. But doing further research, we know that
Vioxx liability does exist.
New Competitors with Better Products. When new
competitors sprung up, the company that you hold might have to
spend more money in order to fend off competition. Recent
example include the emergence of pay-per click advertising by
Google. If you are in the advertising business such as
newspapers or cable network, this new product by Google might
hurt your profit margins and eventually the fair value of the
stock.
Exodus of Talented Employees. Talent is an asset. Yet, it
does not appear on the company's balance sheet. Companies that
rely heavily on intellectual products need to keep their
employees happy. They are prized assets. When employees defect,
it will affect the company's future earnings. Lower future
earnings means lower fair value for the common stock. A recent
example include several Microsoft key employees defecting to
Google.
Not having a valid reason to Buy. When you don't know why
you bought a particular stock, you won't know how much your
potential return is or when you should sell it. This is the
easiest way of losing money. When you have no valid reason to
buy, you should sell immediately.
Stock Reaches Fair Value. This is the easiest part of the
problem. Yes. We should sell when a stock reaches its fair
value. It is the main reason why we chose to buy it on the first
place.