When should you sell stocks?
From a cold, analytical point of view the answer would seem apparent. You sell a share when its market price is above its intrinsic value. On the other hand, if the market price is lower than the intrinsic value, you would buy it back.
Simple. Buy low; sell high right?
Yes and no.
Right now, most of the big banks in the US are advising corporate clients to issue new shares and raise capital.
They’re essentially advising their clients to sell shares in their own companies because the market prices are so far above reality, they don’t believe their clients (the companies) will be able to raise capital at these extended valuations for much longer.
This reverses a long-standing trend of US companies buying back their own shares to improve earnings and boost stock prices.
They are essentially calling the top.
And when you’re as influential as the likes of Citigroup it’s also possible you’ll create the top.
The most recent and extreme case of flogging expensive scrip to shareholders was an application by Hertz (HTZ), after filing for Chapter 11 bankruptcy, to raise $500 million.
The car rental firm, facing imminent demise, saw a lifeline after the market priced its essentially worthless shares at around $5.
This put the destitute company on a market capitalisation of $1 billion. The decision for management couldn’t have been a difficult one.
You have a bankrupt company.
The public is willing to buy it for $1 billion.
When do you sell stock?
The challenge, for regular retail investors, however, is they’re almost always minority investors. They don’t usually influence rights issues or company policy. The decision they have at any point in time is to either buy, sell or hold their shares.
So, should you just simply trust the valuations?
You might think selling your expensive shares is a good idea, but history tells us otherwise.
To get a fair value on your company, you might look at the discounted present value of all future cash flows. This allows you to form an opinion as to an intrinsic value of a stock.
This would allow you to buy a share when it’s below your valuation and sell a share when it’s above.
This is essentially the core idea in the “value investing” approach followed by Warren Buffett and many market legends. The problem with adopting a value approach currently, is that it has largely underperformed “growth investing” since 2007.
As crazy as it sounds, it means basing your decision to buy or sell stocks on what they’re actually worth would have resulted in substandard performance for more than a decade.
As the old saying goes: “Markets can remain irrational longer than you can remain solvent.”
In the case of a money manager, 13 years of underperformance versus the market, usually means you don’t have any client assets left to manage. Your investors have become seriously peeved and you’re probably questioning your decision to enter the industry in the first place.
So instead, let’s perhaps consider the wisdom of legendary hedge fund and investor George Soros:
“When I see a bubble forming, I rush in to buy, adding fuel to the fire. That is not irrational.” – George Soros
Basically, his philosophy turned the value approach on it’s head, advising investors that better risk-adjusted returns would be made by buying into a bubble and trying to time the top with your exit, rather than staying out of the market, missing the run up, and then trying to time a re-entry lower down.
So, you should hold stocks and then sell them just before the bubble bursts?
Easier said than done I’m afraid.
At the heart of the matter, is the investors ability to time the market.
How good will you be at the incredibly difficult task of balancing the underlying intrinsic value of a stock versus the irrational exuberance that creates the bubbles?
How confident are you? can weigh these two competing forces and successfully not only call the top, but get back in at the right level?
History tells us retail investors are not very good at this. From a performance point of view, you’ll be better served by another old adage:
“It’s time in the market that matters, not timing the market.”
So, considering it’s likely too difficult for you, as a non-professional investor, to have any chance of accurately gauging the interplay of the value and momentum and accurately predicting the moment to sell stock it begs the question:
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When is a reasonable time to sell stocks?
The first thing you need to do is assess who you are and why you own stocks in the first place.
Making money is the obvious answer, but totally unhelpful.
What matters more is your personal situation, motivations and risk profile.
There are many reasons you might hold shares but there are only a few reasons to sell them.
Here they are:
1. If you’re in the market for a bit of fun. If it’s your hobby and you enjoy a bit of risk. In short if you’re a speculator, then you should be using a technical system which highlights buy and sell levels. You should likely have a plan to exit before you even enter a position. If you consider yourself a “day trader” the right time to sell is before the close of business that day so your account is square and your broker doesn’t have to hassle you for margin calls.
2. If you’re a long-term investor, you should only sell when there is a significant and permanent change to the outlook of the company. Good advice would be to buy quickly and sell, very, very slowly. We know, when it comes to shares, the idea of buy and hold forever doesn’t work. If you consider Top40 companies from 30 years ago you’ll be hard pressed to find any in the current constituents. And the biggest and best companies of the S&P500 in 2030 most probably have not yet been founded. The companies that are seen as indomitable titans today will be penny stocks tomorrow. If you’re holding a broad-based passive tracker ETF. No problem, the underlying adjustments are being done for you. But if you’re investing directly in shares, you need to make these adjustments yourself.
3. When your portfolio becomes unbalanced compared to your risks. Naturally in any portfolio you will have your star performers and your dogs. The wonderful thing about taking a portfolio approach to investing is your dogs get smaller and your stars, get bigger. The problem comes when your stars start to take such a central role in your portfolio that the combined effect of all the shares no longer suits your specific risk profile. It might be wonderful to see Amazon grow to 25% of your portfolio, but you need to look at the overall risk. What if something should something happen to Amazon? If suddenly it turns out widespread accounting fraud has hollowed out the company’s balance sheet, are you prepared to lose 25% of your cash? If the answer is no, then you should be selling down your holding to a more reasonable level.
4. In a personal liquidity event. The wonderful thing about owning direct stock portfolios is you’re usually not bogged down by retirement regulation or complex structuring requirements. That means you can usually sell shares quickly and easily. Global market standard these days is T+3. That means from when you sell a share you can have cash in your hand 3 days later. This is particularly useful when managing unexpected liquidity events. Ideally you don’t want to sell but having direct stock investments allows you to often self-insure small losses (save insurance premiums) because funds are accessible, and you can more flexibly managed your personal liquidity.
5. Finally, for tax purposes. If you happen to go through a year of very low income. Say you take a year off and didn’t generate as much income as you thought. Perhaps coronavirus has seen you furloughed on unpaid leave. It’s often useful to use low-income years to realise some of the CGT that has built up in your portfolio. Of course, this is a very personal and very unique decision. Financial matters are usually complex. If you’re investing everything through a Guernsey trust for example this might not be a consideration, but if you’re holding direct stock in your name and go through a low-income year, realising some of your profits and redeploying can solve larger CGT challenges later on. Investment bankers are usually very keen to delay your tax as long as possible (perhaps they prefer to earn higher fees on the larger untaxed amount) but taxes are inevitable. Trimming positions to manage your tax rate helps keep things simple.
The tax aspect of share sales can be more complex and there are many ways of using your share portfolio and financial instruments to improve your tax position. For example, if you do have a large position that you believe has run too far, and decide that you’d like to sell but are afraid of the large CGT it will trigger, you could also look at various derivative contracts which allow you to reduce your risk, while avoiding the tax impact.
As with all matters relating to tax, investment and portfolio management, I would highly recommend using a professional financial advisor who understands your personal financial position. Money Morning
readers are better informed than most retail investors, but the value of good financial advice cannot be overstated. If you’re looking for assistance on your personal share portfolio feel free to contact us directly on firstname.lastname@example.org
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Rand Swiss, Wealth Manager