The stock market's recent rise to a record high means that many investors may have accumulated significant profits. As a result, they may be tempted to sell some of their holdings.
However, selling shares based on the amount of profit they have made for an investor could be a dangerous game. Higher price levels do not necessarily mean further gains are less likely.
Therefore, in my view, reassessing the investment appeal of holdings on a regular basis could be a more logical approach. It may lead to a more productive use of capital in the long run.
Selling based on returns
The stock market's recent rise has been rapid. Indeed, the S&P 500 has gained 85% since reaching a three-year low in March 2020. Even so, its surge is not particularly large for a bull market. The average bull run since 1928 has prompted a more than 100% increase in the price level of equity markets.
In addition, the current bull market has lasted for little over 12 months. By comparison, the average bull market has survived for just under three years. Of course, one potentially confounding factor to consider is that the most recent bull run began when stocks were already trading at high valuations.
This does not mean that further stock market growth is a given. After all, its future performance is impossible to accurately predict. However, it shows that equity prices are not necessarily due for a decline solely because of their recent gains. In fact, some companies may still be undervalued – even if an investor who holds them is making high levels of profit.
As such, assessing each company on a case-by-case basis could be a productive use of time at the moment. Analyzing a stock based on factors such as its prospects and valuation may mean that it is worth selling after its recent rise. However, analysis may also indicate that some stocks have not yet reached their intrinsic values. In those cases, they may be worth holding instead of being sold.
Walter Schloss' viewpoint
This viewpoint is similar to that held by Walter Schloss. He had a long and very successful career as a value investor, during which time he delivered a 21% annualized return over a 28-year period. Schloss previously stated:
"Don't be in too much of a hurry to sell. If the stock reaches a price that you think is a fair one, then you can sell but often because a stock goes up say 50%, people say sell it and button up your profit. Before selling try to re-evaluate the company again and see where the stock sells in relation to its book value. Be aware of the level of the stock market. Are yields low and P-E ratios high. Is the stock market historically high? Are people very optimistic etc?"
Schloss's view may also be relevant at the present time because of the opportunity cost inherent in selling shares. Assets such as cash and fixed-income securities offer particularly low returns compared to their historic levels due to an accommodative monetary policy. Therefore, selling stocks at prices that do not fully reflect their intrinsic values to move into cash or bonds could prove to be an unproductive use of capital.
Clearly, investors may wish to look at metrics other than Schloss' book value, yields and price-earnings recommendations. Similarly, the level of the wider market may not be all that helpful in determining whether a specific stock's price has scope to move higher. For example, not all shares will have matched the stock market's recent gains.
However, following his advice to ignore recent returns and to act on each stock based on its own merits could be a means of allocating capital efficiently.
Disclosure: The author has no position in any stocks mentioned.
Read more here:
- Joel Greenblatt: Search Unpopular Sectors for Bargain Stocks
- Warren Buffett: Less Activity Can Produce Higher Returns
- Howard Marks: Contrarian Investing Produces the Best Results
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