Deciding when to sell is, in my opinion, the hardest part of investing. There is no real definitive answer to the question. Experience helps, but ultimately, selling is a very hit-or-miss topic for investors.
First of all, you have to acknowledge that no matter how hard you try, you will always sell at the wrong time. Market timing is almost impossible and the chances of correctly calling a turn in the market are close to zero. That is why the world’s greatest investors always build a margin of safety into intrinsic value calculations. You need to sell when you believe the stock in question has reached your own estimate of intrinsic value, not when you think the market is about to roll over.
On some occasions, it might not be possible to sell at your estimate of intrinsic value. If the company suddenly runs into trouble or you lose confidence in management, it might be better to sell and never look back. A bust investment thesis is yet another reason to sell and never look back.
Lying, cheating and overvalued
Misleading statements from management can be extremely toxic for investors. If management lies to its shareholders, how can you trust the rest of the business is operating without hidden cultural problems?
Management’s disregard for shareholders might act as an incentive to lower-level employees to mislead or lie to their supervisors. In this situation, it might never be appropriate to wait for the share to reach intrinsic value or even arrive at a better level to exit. There is no telling how deep the rot goes, and if you cannot trust management, does the initial investment thesis still apply?
Of course, it is different if you are trading the share price. In this situation, the underlying fundamentals do not matter as much, and if management is juicing the figures to get the best earnings results, as a trader you are probably not to be around long enough for it to impact you.
A bust investment thesis is another reason to get out and not look back. Investment theses are the investor’s roadmap. Without them, you are purely speculating on share price, with no knowledge of the underlying business or estimate of intrinsic value. Having an investment thesis is fundamental to calculating intrinsic value, planning your trade and watching the company as it develops and grows.
If there is something you are on the lookout for, such as declining profit margins, which could signal a decline in competitive advantage, the investment thesis is an excellent handbook to go back to for reference.
If the argument is broken, it is a strong reason to sell. You could adjust the thesis, but then you open yourself to the risk of psychological biases such as loss of avoidance, which may convince you the current situation is not as bad as it could be, therefore convincing you to hold on and readjust the thesis to a positive conclusion.
Having said that, business is not a precise art. There are bound to be some problems or unforeseen developments that occur. A solution to this issue could be to calculate a range of outcomes before investing, covering all bases. That way you can still view the opportunity through a nonbiased lens because while you are determining if you should buy the position to being with, it should be from a neutral base with no particular bias either way. If you start your analysis with either a bullish or bearish preference, you are doing it wrong.
Plan before you jump
Overall, I think one of the best observations about selling is to know when to sell before you initiate a position. If you have a set of guidelines and valuation scenarios in place before you enter a position, there is no chance of being swayed by psychological biases or changing the thesis to adapt to the new environment. Updating the thesis as new information emerges is vital, but this should also be conducted with a balanced view.
