Decoding when to sell

Reams of paper have been expended on identifying and investing in a right stock. Of course, this is an important and beginning aspect of an investment. While an equally important part of investing decision is to know, ‘when to sell?’ - there’s scare information available in public domain on this. This is probably the reason why people accept multiple styles or strategies at approaching the markets. That’s an easier and convenient way to come with a comprehending explanation to the unknown or unexplained part of investing.

While we always identify a potential investment based upon various parameters, it would be realised only after the thesis or conditions turn in our favor. After an investment is committed, price is the only judgement that defines how we fared on the investment. There would be multiple times when markets don’t favor our investment despite it being of a sound rationale.

The other factor in this judgement is the time. Time is the biggest neutralizer, for a splendid multiplier to mean revert or cover debilitating losses to decent earners. May be our bet has turned exponential returns in a very short span of time, only to give away all those gains while we persisted with our position, or the investment didn’t pan out as planned initially only to generate higher returns down the line. So overall, an investment decision is bound by how it transpired within a defined time.

It's this dynamic that drives many to invest in an index rather than try pick and gain on a single or few stocks of choice. But the active managers’ or investors’ logic stems from, not owning, what’s unknown or un-understood. Why diversify into unrequired assets just to reduce the risk. This debate has winners on both the sides, though. And then there’re investors who won’t sell at all, nothing wrong but not completely correct too.

That’s possibly why many of the investors exploring fundamental analysis utilise the same metrics to find out if they’ve to divest the stock. While picking up a business, one would look at the competitive advantage aka moat the company/ business has within the industry, the potential challenges the business faces and how efficient the capital is being deployed. I guess these three concerns could address on how the company is doing and would do well.

Some businesses derive advantage purely from the existing laws and/or regulations. The laws turn them into monopoly or a commanding position which allows them to generate profits on a consistent basis. In most other cases, they could devise a flywheel which helps them to be either/all being productive, innovative and efficient in their processes of production, distribution and management. If the business continues to exhibit i.e., retain the profit margins along with the sales growth then they could be considered with a long rope.

If there’s a change in the status of the invested business ie, regulatory or law changes, entry of new capable competitors and/or technological advancements, one should check how well this business is able to cope and counter. Most times it needs agility and adoption to these changes that helps them to sustain the business. Any alternative action could derail our initial thesis on the business prospects. That could provide the first hint of taking stock of the situation to assess if one were to continue with the investment.

Capital allocation is not just the key for its present status (financial) but also its future possibilities. Those companies that have a greater vision, invest in technologies or processes that benefit them in extending their moat into the future. Good managements not only create huge moats due their practices but ensure to retain them for extended periods of time by modernizing or implementing measures to the changing environment. If one were to identify this quality among the businesses that were invested, then it helps one to persist.

Every opportunity to buy is someone else’s equally interesting exit. The reason could be the fructification of their rationale or just their emotions got better of them. And while the market movement is about the demand and supply it’s primarily a reflection of the collective emotions of greed and fear. We may add couple of more emotions ie, validation and regret. While the aspirations inflame greed, the threat produces the fear. Validation is a critical behavioural trait that could make or break our rationale into a fallacy.

The confirmation bias leads us to search and accept all those information that validates our rationale, it could debilitate if we’re not open to criticism or alternate possibilities. A critical analytical approach is necessary to avoid falling prey to this. Regret avoidance bias where people tend to not act as the decisions could later create regret is possibly the worst bias to harbor. Again, this could be overcome by understanding self, knowing the risk profile properly even before making an investment.

If properly done one could easily make a sell decision which completes the investment journey.

(The author is a co-founder of “Wealocity”, a wealth management firm and could be reached at [email protected])