With all the focus on when and what to buy, the decision to sell can often be neglected, but it is still important.
You should sell a stock when the fundamental and future prospects of the company change, not because the price has gone up.
Reasons to sell
You made a mistake
If you have bought a stock and the story does not turn out to be as good as you were lead to believe and you don’t think it is a good company any more you should sell, sooner rather than later. This money than can also be re-invested in other opportunities with better prospects.
This is hard to do due to human nature, not wanting to admit mistakes – our ego. In psychology terms this is called ‘regret avoidance’ You have to remember the losses will be small if you don’t procrastinate when you realise your mistake and your wins will far outweigh these.
Fundamentals and prospects change in time
When you have bought a good company and the fundamentals have changed and the future prospects do not look good it is time to sell. A common reason for a deterioration in the company is due to management, maybe they have got complacent due to success and the drive is not there anymore or there have been changes in management and they are inexperienced or just not up to the same standard.
Another reason is that the growth prospects of the company are exhausted. The company may have been a fast grower but with the growth prospects exhausted, the company will only grow along with the sector as a whole and the economy.
In this case, the selling will hopefully not to fast to give you time to look for a more suitable investment. Capital gains tax should not be a deterrent to sell and invest in something with better prospects that is at the early stage of growth, as this company once would have been.
You find another company with better prospects for growth
Investment opportunities can sometimes be hard to find, so if you do come across one with significantly better growth opportunities and you do not have available funds, you can sell a company you already own with a less attractive growth rate and switch to the new company, yes there may be capital gains tax, but overall if you have done your homework and are sure of the new company’s prospects then in the long term there is good chance of it working out.
Reasons not to sell
The company is affected by short-term or external factors
You must be careful not to sell when short-term events that do not change the fundamentals of the company come out. For example, a company may lose a customer and news comes out and the price declines, but the company may have many customers and it turns out to not affect the company as much as first thought. In these cases, you can look at the long-term outlook and maybe pick up more shares at a depressed price.
If you know the company and industry, you will be able to view negative news more clearly in relation to the long-term fundamentals of the company and are more likely to make a rational decision about selling, maybe buying more or that most underrated of investing actions – nothing!
A stock market decline may happen
Stock market news is constantly telling us to do this and that and this and that will happen and reasons why you should sell your stocks.
One reason for this advice is that there will be an impending decline in the market. As no one knows what will happen in the future so this is not a good reason to sell as the market can keep going for a long time.
Selling growth stocks when they become expensive
It is hard to anticipate what a company’s earnings growth will be in the coming years, so how can we say what’s expensive? There may be new products or initiative in the near future that the market has not factored in and if the company is going to four times as big down the track, why sell because it is overpriced by 20%.
The idea is to do your research when buying stocks, so there is less chance you will have to sell.