When to Sell Your Shares

There are generally three main reasons for investors to sell out of their equity position

Chris Menon 20 February, 2013 | 11:44AM
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This article is part of Morningstar.co.uk's Equity Investing Week.

Every investor dreams of buying equity that steadily rises in value, delivering both capital appreciation and progressive increases in dividends. Few consider when to sell.

More money has probably been lost by investors holding a stock they did not want until they could ‘at least come out even’ than from any other single reason

Certainly, if you’ve chosen wisely and found a great stock, there really shouldn’t be any reason to sell. That is why Warren Buffett says his ideal holding period for an investment is “forever”.

Still, since few are as skilled in stock-picking as the Oracle of Omaha, it is very important to clearly identify the circumstances that may lead you to sell a share.

These reasons exclude forced sale due to the need to have cash immediately, for example, to pay school fees or fund a house move. Money that might possibly be needed in the next couple of years to fund a house move or pay school fees is best not invested in the stock market.

There are essentially three main reasons to sell a share:

1. Poor Choice

Firstly, when your original decision to invest was mistaken and it becomes increasingly clear that the company in question is not as good an investment as you had supposed, you need to be tough enough to sell.

While easy in theory, cutting your losses requires emotional control and an ability to face hard facts. The biggest obstacle to selling under such circumstances is the ego and a perceived loss of face.

Remember the wise words of Philip Fisher: “More money has probably been lost by investors holding a stock they did not want until they could ‘at least come out even’ than from any other single reason.”

If a mistake is quickly recognised, the share can be sold, avoiding the danger of further losses. More importantly, by employing the funds in a better-quality business you should eventually recoup any short term losses.

It is natural to make mistakes and, as investing is as much an art as a science, all investors sometimes lose money. However, the smart and successful ones know when to cut their losses.

2. Company Changes

The second reason to sell is when the company changes to the point that it no longer qualifies as a sound investment. For example, it may be that a very successful chief executive leaves and is replaced by much weaker management, or the company’s successful strategy is altered and, as a result, margins start to decline. When this happens it can pay to take your profits and exit quite swiftly, irrespective of any capital gains you may pay or the fact it is a bull market.

If growth slows down at what was previously a fast growing company, it may be that its growth rate has reverted to the mean because there is no prospect of increasing its market share. If it isn’t innovating and driving into new markets under those circumstances, it may also make perfect sense to sell. However, it may also be a pause for breath before the shares move on to new heights.

When in doubt, you can decide to sell off your stake in a more leisurely manner. Indeed, many investors opt to sell part of their holding when a company’s shares double or triple, which allows them to lock in gains and reduce the risk of making a future loss. It’s all a question of judgment, requiring detailed knowledge of the company in question.

3. Better Opportunity

The final reason to sell is when a better opportunity arises elsewhere. Now this is very tricky if the company you are selling has performed well and you understand its business.

Given that investors (both professional and private) often make mistakes, selling a winner too early and reinvesting the proceeds can be risky. It is a bit like pulling up a prized plant to put in a seed that you hope will grow bigger.

This move certainly shouldn’t be done on a whim simply because a broker has a hugely inflated target price for a particular ‘hot’ stock or because a mate has given you a tip.

Similarly, it isn’t sensible to sell a winning share because the consensus is that it has become over-priced. After all, on that basis, Buffett never would have bought Coca-Cola (KO) shares and investors in ARM Holdings (ARM) would have sold out long ago.

Deciding when to sell is one of the biggest decisions investors must make. Time spent examining your motivations and the prospects for the company should reduce the risk of making a costly error. 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Coca-Cola Co62.55 USD0.07Rating

About Author

Chris Menon  is a financial journalist writing for Morningstar.co.uk.

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