Buying shares appears relatively simple, especially when you compare it to selling.
When we buy shares in a company, it's fairly straight forward.
My process usually involves running through a list of the stocks I already own, looking for those that are relatively cheap. I then consider if there are any new candidates that I might want to add to that 'buy' list.
I then weight up the pros and cons of each of the stocks on my 'buy list' and depending on how much I have to invest, pick the top one or a number of them. Then I simply place the order/s with my online broker.
When it comes to selling – that's a much harder decision but we can make it easier for ourselves by asking a number of questions. Usually, selling can involve making two decisions, with the second question being what do I do with the proceeds from the sale? That could involve adding the 'buy process' mentioned above.
Firstly, we need to ask why we are selling shares in a particular company and it should generally be for one of the following 9 reasons.
- Has the financial performance of the company deteriorated that badly, and is there any sign of recovery? If the answers are yes and no respectively, then we absolutely should sell our shares. What is important is to not only base your answer on the expert's views, but on your own research and the company's financial results. The experts don't always get it right.
- Has the company changed strategy or direction? I recently sold out of TFS Corporation Ltd (ASX: TFC) because the company has changed in what famed investor Peter Lynch labelled 'diworsification'. TFS could be liable to pay out up to US$245 million for the purchase of ViroXis and Santalis, two pharmaceutical/biotech companies, not to mention substantial funding of Phase I, II and III trials to get a number of products to the commercialisation stage.
- Have you identified a better opportunity? In some cases, you might not have the cash to buy shares in a company without selling something first. If that's the case, then investors can simply sell their least 'comfortable' stock. And by that I mean the company that you have the least confidence of outperforming the market for any number of reasons.
- Have the shares become overpriced? Looking at vitamins and supplements supplier Blackmores Limited (ASX: BKL) as it share price soared above $157, it's fairly clear that shares were overpriced. In some cases, you may want to sell down only a portion, maybe a half or a third of your holding – putting the cash aside to buy more when the price tumbles.
- Has your personal situation changed, so you need funds? Sometimes life happens and you may need cash for any number of reasons. Theoretically, it's better to have some cash reserves to meet sudden issues, but it's not always possible in practice.
- Do you need to rebalance your portfolio? In some cases, some stocks may become a significant portion of your portfolio if the price appreciates significantly. In that case, investors may want to sell a portion to bring it back within an acceptable level.
- Tax. In some cases, it may be worthwhile clearing out losing stocks from your portfolio to offset capital gains during a financial year.
- A change of strategy. In some cases, you may find that the stocks in your portfolio don't match the plan you have for your portfolio. A self-managed super fund (SMSF) shouldn't be used to hold a high proportion of speculative stocks, so you might want to balance that up, by shifting your portfolio to a strong base of dividend paying blue chips and high-quality growth stocks.
- Did you make a mistake buying the shares? Bought the wrong company, bought too much of a company's shares, or did you just make a bad decision when buying in? This could be for all manner of reasons – including buying a hot tip when you shouldn't have, not understanding what the company really does or having unrealistic expectations.
Any other reason for selling, such the market is falling, you are worried about the future direction of the market, or the share price is down 10% or 20% are not valid reasons for selling (unless they are also one of the above reasons). Markets usually recover fairly quickly and share prices can quickly turnaround, particularly if the company is high quality.
Reject Shop Ltd (ASX: TRS) has seen its share price fall from above $15 to around $5 from early 2014 to June this year, but have since put on more than 70% after the company reported a much better 2015 financial year result. So much for those that wrote the company off.
Foolish takeaway
Perhaps one of the most important takeaways is to jot down the reasons for buying a stock and perhaps record how long you intend to hold onto the shares. The more detailed your explanation, the more likely the selling decision becomes easier. I've also setup a checklist on Google Sheets to help answer the above questions.
