When to sell a stock? That’s a question that differentiates experienced investors from beginners. Selling too early can lead to massive regrets when the price goes parabolic after you sell. On the other hand, holding a stock for years hoping for the price to go up isn’t great either.
In this post, I will be sharing what I consider before selling the stock of a company.
Disclaimer: None of what I’m talking about should be considered as financial advice. It is for entertainment and educational purpose only.
The Fundamentals Has Changed
The future is unpredictable. A black swan event can happen and completely change a company forever for better or worst. As an investor, when big changes happen to the companies you’re invested in, you’ll need to evaluate what future impact it will have. If the company is worst off it might be a sign to sell.
Some examples of fundamental changes are:
- Something happened that lead to the company taking on massive debt
- Something happened that lead to the company seeing an exponential increase in the demand for their product(s)
- Something new that is far superior and cheaper is out in the market at scale compared to the company you are invested in
- The company was not being transparent (lying) about its progress
These are all things to watch out for with your investments. Bad changes to the fundamental is usually a signal for you to re-evaluate the company and decide if you want to stick with the investment.
Valuation Is Misaligned With the Fundamentals
When valuation is misaligned with the fundamentals it can be a buying or selling opportunity. It comes down to the market capitalization (market cap). In the case of selling, the market cap is significantly higher than the fundamentals of the company.
For example, a company’s market cap is in the billions, but they don’t have a product out yet. You can make a good guess that the stock price is fuel by nothing but hope, hype, and/or dreams. Price can always go up but there would be other better opportunities out there with much less risk. So, if the company grew from a market cap of millions to billions, while there was no change to the fundamentals it warrants looking into selling.
Another example is with a company that has a nicely growing business. The market cap has gone up so much that it would take the company many years of steady growth to catch up to the valuation. In such a case, the upside for many years ahead is priced in and the stock is priced for perfection. In this case, any good news won’t add much, while the tiniest slip-up would cause the price to fall. When the risk and reward become extremely one-sided, it is a sign to consider selling.
You Don’t Like the Direction the Company Is Heading
Evaluating the management team of a company is a challenging task. Based on their prior actions you might find them to be executed really well. So, you invest in the company because you believe the management is great. However, sometimes after you invested in the company, the management team might do something you didn’t expect and it is what you believe to be bad for the company. In such a situation, it might be time to sell the stock. It is difficult to stick with investments that you don’t believe in.
Let’s take, for example, you initially invested in a company because they’re focused on innovating and delivering a superior product than others. Then one day the management team comes out and says they’ll stop focusing on innovating. Instead, they’ll distribute all the profit back to the shareholders as dividends. If you’re expecting the company to keep innovating to stay ahead of others then their decision to stop would go against your thesis for investing in the company. While your investment thesis should evolve over time with the company, it shouldn’t take a U-turn.
Your Narrative For the Company Has Played Out
You’ve done your due diligence and the company you invest in grew within your expectations. So, is it time to sell since it has reached your target? Well, that depends on if the fundamental has changed since you invested. If there are new areas that are big opportunities for the company since you checked then it might not be time to sell. However, if there are few growth opportunities left then it might be time to exit.
At the end of the day, there is no perfect list of items to check off to decide when to sell the stock of a company. The points in this post are a guideline of important things to consider to help make the decision to sell easier. Something important to note though is nowhere was how much capital you will lose if you sell is part of the equation.
I hope this post was helpful to you. If you found this post helpful, share it with others so they can benefit too.
To get in touch, follow me on Twitter, leave a comment, or send me an email at steven@brightdevelopers.com.