When to Sell a Stock

Many investors buy stocks with pre-defined sell triggers in mind. "I'll sell the stock in 1 year", "I'll sell the stock once it gives me a 50% return", "I'll sell it when it once the current acquisition plan is finalised", etc.

Value investors, however, look at selling stock holdings in a very different way. To value investors, there are only 3 reasons to sell stocks:

1. The valuation becomes too expensive. eg: the stock was trading at a P/E of 10 at the time of purchase. After 2 years of patient holding, the stock has now reached P/E of 20, which is much higher than the historical average for the company, as well as higher than the industry average. Time to Sell!

2. The original investment case is no longer valid. eg: Mr. A invests in a stock in the real estate industry, because he believes that the then benign interest rate scenario is very favourable for the real estate industry. However, the rate cycle eventually turns and rates end up becoming high enough to begin to hit real estate sales. Clearly, the original investment case (Low interest rates = good time for real estate stocks) is no longer valid. Time to Sell!

3. A better opportunity comes along. eg: Mr. A decides to invest in an auto stock because he believes that as India's middle class gets higher disposable incomes, the demand for automobiles is going to rise exponentially. However, after looking at the value chain of the auto industry, he feels (rightly or wrongly) that rather than the auto manufacturers, certain auto component manufacturers are the ones who are actually cornering most of the profit margins in the industry's growth. Time to exit auto & enter auto components.