Often, you get advice on how and when to buy a share whereas not much of the literature is available on when to sell them. The decision to sell the shares is as important as that of the decision to buy shares. So, next time when you place an order to sell your shares, consider the following essential elements.
Why did you buy them?
Before selling, ask the question, why did I buy this share? You might have bought the share as the company was generating good and consistent sales, profit over the past and expected to have a growth with a competitive advantage over other companies. Check whether any of the above characteristics or fundamentals of the company has changed recently within the company or across the industry in which it operates. If you believe that there are definite and visible changes on the above parameters, it could be a good reason to sell. However, do not sell the share because there is a decline in price.
Any significant change in leadership?
Investors buy shares not just looking at future cash flow, sustainability of the business model but also look at the top management of the company. When there are some sudden changes at the top level, the company can to some extent lose its long-term vision. Any such changes will affect the future earnings, cash flow and thus share price. However, despite the changes in the top management, if the company delivers the returns as promised to shareholders then hold on the shares. If not, then go ahead and sell them.
Any deviation from established dividend policy?
When a company, which has a generous dividend paying policy suddenly announces a significant dividend reduction or cut in dividend you should be alert. Probably, the company want to conserve cash to invest in capital expenditure, acquisition, expansion, diversification, etc., which is a good move and this action is expected to generate more value for the company in future. If you understand that the reasons are different, then probably it is a time to exit.
Is the share over valued?
Every investor wants the share price of the stocks he holds to go up. If it is overvalued, it could be a good reason to sell. However, you must ensure whether the current valuation is justified. For instance, if the share is trading at 25 times earnings whereas its peers are trading 15 times with similar growth metrics and characteristics, then it is a case of over-valuation. Generally, a relatively high price earnings ratio indicate that a share is overpriced and ready for a plunge.
Are you in need of liquid cash?
Investing equity shares as an asset class is a good idea only when you have reasonably longer holding period of three to five years. If you need good returns from your shares within a year or so to cover certain unavoidable expenses such as sending your child to university, etc., it is a good idea to offload some part of your equity share and focus on preserving your capital.
To conclude, you should take a call to sell the shares either to protect your capital or to harvest gains.
The writer is associate professor of finance & accounting, IIM Shillong