A lot of emphasis is put on “when to buy a stock” but little is talked about “when to sell” a stock. Getting the ‘sell’ strategy right is as essential as getting the ‘buy’ strategy right. Exiting too early may mean forgoing a lot of gains that were there to be made. And, clinging on to a stock when the best has already played out, and opportunities elsewhere is also not ideal.
So, when is the right time to sell? Well, there are no definite formulas or answers. The Market often behaves in an irrational manner. However, one can decide when to sell stock and plan their exit in a better way. Here is a guide for that. We have divided the factors into fundamental and non-fundamental reasons for better understanding:
Let’s first look at fundamental reasons to sell:
Valuations
Valuations are one of the main guiding lights to buy or sell a stock. Typically, the market/ sector/stock trades at certain price-to-earnings (P/E) multiples, known as historical valuations. If the stock/ index starts trading at a premium to its historical valuations, it can trigger selling. Similarly, when they slip below the long-term average valuations, it can be a reason to buy. The markets and stocks rarely move in a linear fashion. They tend to overshoot and undershoot its fair valuations—which presents good selling and buying opportunities.
Sharp run-up in price: It could be a good time to sell if the price no longer supports the fundamentals. This happens when the financials or the performance of the company fail to keep pace with the stock price rise. This could happen due to excessive speculation, too many investors chasing a single stock/theme, overoptimism by investors. Often it is best to take money off the table during such instances. If you still love the stock, you can keep the powder dry to re-enter the counter if the price falls below your selling price.
Earnings trajectory: A listed company is mandated to disclose its financials after every quarter. Usually, while disclosing the financials, the management also presents the growth outlook and offers commentary on key aspects. One needs to analyse the same to understand the growth trajectory of a company. Any disappointment in earnings or missing growth targets could result in stock price correction. If a company consistently misses estimates, it could be a reason to sell. One also needs to keep an eye on profit and operating margins, as they tell us how efficient the cost structures are.
Governance track record: Corporate governance practices followed by the management or the promoters have a bearing on the performance of the company and its stock price in the long run. Whenever there are any red-flags around governance, one needs to assess whether they want to stick with the company or switch to another one in the same sector but with better governance..
Leadership/market share/moat: Companies that are market leaders or enjoy a large market share tend to perform well. Here investors should track if the company is able to maintain its leadership position and market share. An entry of a new or aggressive player could challenge the leadership position and impact the performance. This could be a trigger to sell. Also, if a company has a strong product offering that gives it distinct advantage over competition it could act as a ‘moat’. A moat helps protect market share and margins. For instance, Apple has a moat in the form of the iPhone. Moats are hard to replicate. But if the product positioning is under threat, it can be a reason to sell.
Rising debt: Rising debt levels are a definite red flag. Unsustainable debt levels have triggered the collapse of many companies. Investors should evaluate metrics such as debt-to-equity ratio and interest coverage ratio. If they start flashing red signs, it could be prudent to exit the stock.
Large fund raise or share sale: During its lifecycle, the company may require capital. To meet this requirement, the company may issue new shares to investors, resulting in dilution of holdings for existing investors. While a fresh fund raise is not a sure sign to sell, it could weigh on the stock in the near-term, particularly if dilution is large. This can be used as a selling opportunity. Also, if the company frequently needs capital, it could be a red-flag as it means that the company is not able to sustain with its profits or cash flows. Also, there are instances where a large private equity investor or the promoter has to sell a large chunk of their shares. This too could put downward pressure on the stock in the near-term.
Market conditions: The underlying market sentiment can offset other fundamental factors, at least in the near-term. Investors tend to overlook valuations, earnings and governance issues during a bull run. Similarly, during a bear market these factors may go under-appreciated. During such times, one can take the top-down approach. It means one needs to see what is powering the bull or the bear market before they start analysing a company. For instance, easy global monetary policy and liquidity has underpinned the market up move from Covid-19 lows in March 2020. Here the sell signal could lie in what is happening with global interest rates and monetary policy rather than a company’s individual performance.
Sector outlook: A company’s fortunes are tied to the sector or the industry it operates in. One needs to evaluate the prospects of the industry—whether the company’s main product will stay relevant 10 or 20 years from now? For instance, a company manufacturing storage media like CDs & DVDs could become obsolete unless it successfully transitions to modern technology. Probably, 10 years from now electric vehicles (EV) could replace combustion engines entirely. So an automobile company without an EV strategy may not be able to sustain. An investor needs to study the long-term structural drivers for the company or the industry before taking a buy or a sell call. In the short-term also, certain sectors could flash buy or sell. For instance, last year stocks that benefited from the stay-at-home theme (streaming companies, food delivery, mobile and laptop makers) did well. On the other hand, stocks that benefit from the get-out-of-home theme (hotels, malls, airlines) fared badly.
Let’s now look at some technical or non-fundamental aspects, which can be used as triggers to sells:
For financial needs: This has nothing to do with any fundamental factors. There will be instances when you will need cash to buy a real estate, fund education, marriage or healthcare expenses. Stocks are liquid assets like bank deposits. One can sell them easily and generate cash. However, in case there are several stocks in your portfolio you can assess which ones to sell based on the points we just discussed.
If you are a trader: Most of the points we discussed above apply largely to long-term investors. The considerations are very different for traders, who buy and sell at a much greater frequency. Stop-losses, prevailing market sentiment, near-term triggers and news flow often take precedence over fundamental factors discussed above for a trader to sell shares.
So, the next time you can’t decide whether it is the right time to sell a stock, you can refer to the above points to guide you and help you make an informed decision.