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When to sell shares – your essential guide
• The share is overvalued
If a company’s shares trade at say R5 it means that’s what the market is considering the value of a share right now. But a share also has an intrinsic or “real” value. This is what a company is worth based on its present and future cash flows, profits and assets.
That means a company selling for R5 could be worth more or less than R5.
We typically buy shares when their prices are lower than their intrinsic value. And we sell them when their prices are higher than their intrinsic value.
A share could become overvalued if the company’s future prospects deteriorate, the company sells major assets or if the share price ran up way past the company’s underlying value. In this case you could sell.
• Locking in profits
When a stock climbs higher than you purchased it, you’ve made a profit. But a profit on paper means very little until you’ve realised the gains and the money is in your bank account…
You have three options now. You could hold onto all of your shares and see if you can earn even more. This may work, but you also risk losing part or all of your profits. And even your initial investment.
A second option you have is to sell all of your shares of the stock. That will lock in your profits. The only problem with option two is that the stock may continue to rise after you have sold it. Because you no longer own any shares, you won’t be able to participate in additional profits.
So there is a third option. A middle way so to speak. That middle way is selling some of your shares and taking some of your profits. I typically – when a company hits a 100% gain – sell half of the shares. This means all my original capital is back in my bank account, but I still get to make money if the share continues to rise.
• You made a mistake
Nobody’s perfect and we all make mistakes. And its definitely true when it comes to investing.
Maybe you bought into a company because you heard banter about the company at a recent get together with friends… Or you bought a company because you thought it was in a good industry – without doing research first.
But when you come to the realisation that it was a mistake, the business isn’t as solid as you thought or you just completely don’t understand its business model… Well then you need to correct your mistake. Holding on based on hope isn’t an option, rather sell.
• The business has or business conditions have fundamentally changed
When you purchase a share it’s because there are reason behind the company’s future outlook backing up a price increase.
Maybe the company’s been growing sales and profits consistently. Or it is about to launch a new product or service that will see profits soar. Or perhaps it produces a commodity with a rising price.
But it sometimes happens that the driving force behind the reason changes.
Maybe a bunch of new gold mines are shooting up, and by flooding the market with gold the gold price is crashing.
Or a company like Apple releases the Iphone 35 and it is a complete dud.
It could even be that the company is making an acquisition that is changing the shape of the business, or makes it take on too much debt.
No matter – if the business case fundamentally changes you need to re-asses the company and possibly sell your shares.
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• There are superior investment opportunities out there
If you’re holding on to a company that’s set to give you a 3% annual dividend, and you expect it to grow 25% in the coming three years it might be that there are better opportunities out there… Let’s say a bank is offering a 11% annual interest rate on a fixed deposit… Essentially the fixed deposit will give you a ‘guaranteed’ return at a much lower risk than the share.
Or you might be holding shares in a company that’s gone nowhere for years, while you uncover the ‘next hot thing’.
In these cases selling your shares would also make sense – as the expectation of larger returns are there.
The bottom line is – you should sell shares when it makes sense. When there is a logically thought out reason. In fact, you should set yourself rules for when to sell before you even buy a company’s shares.
It’s important to have a plan, and stick to it. Stay rational and don’t let fear and panic drive your selling decisions.
The effect of the corona virus on air travel could be reason enough to sell your shares in airline companies – if you have a short term outlook. But it definitely should not be a knee jerk reaction simply because the market is dropping.
Here’s to unleashing real value,
Editor, Red Hot Penny Shares