When to sell shares: Stock market opportunities and pitfalls
BY Chris Menon
27th May 2023 Investment
Knowing when to sell your shares is a tricky business, but there are some key signs that it's time to sell up and invest elsewhere
Every investor dreams of buying a share that steadily rises in value, delivering both capital appreciation and progressive increase in dividends. Few consider when to sell.
Certainly, if you’ve chosen wisely and found a great stock, there really shouldn’t be any reason to sell. That’s why the world-famous investor Warren Buffett says his ideal holding period for an investment is “forever”.
Still, since few are as skilled in stock-picking as the man known as the "Oracle of Omaha", it is very important to clearly identify the circumstances that may lead you to sell a share.
Thankfully, another legendary investor Philip Fisher long ago explained the three reasons you should sell a share. It was in his classic book, Common Stocks and Uncommon Profits, that Fisher identified the three investment-related reasons to sell a share.
These reasons exclude forced sales due to the need to raise cash immediately, for example, to pay school fees or fund a house move. Money that might possibly be needed in the next couple of years to fund a house move or pay school fees is best not invested in the stock market. There are three main reasons to sell a share:
1. You chose poorly
If it turns out you've made an unsound investment, it's best to cut your losses quickly
Firstly, when your original decision to invest turns out to be mistaken and it becomes increasingly clear that the company in question is not as good an investment as you had supposed, you need to be tough enough to sell.
While easy in theory, cutting your losses requires emotional control and an ability to face hard facts. The biggest obstacle to selling under such circumstances is the ego and a perceived loss of face.
"If a mistake is quickly recognised, the share can be sold, avoiding the danger of further losses"
Note these wise words from Philip Fisher: “More money has probably been lost by investors holding a stock they did not want until they could ‘at least come out even’ than from any other single reason.”
If a mistake is quickly recognised, the share can be sold, avoiding the danger of further losses. More importantly, by employing the funds in a better-quality business you should eventually recoup any short-term losses.
It is natural to make mistakes and, as investing is as much an art as a science, all investors sometimes lose money. However, the smart and successful ones know when to cut their losses.
2. The company changes
The second reason to sell is when the company changes to the point that it no longer qualifies as a sound investment.
For example, it may be that a very successful chief executive leaves and is replaced by a much weaker manager, or the company’s successful strategy is altered and, as a result, margins start to decline.
When this happens it can pay to take your profits and exit quite swiftly, irrespective of any capital gains you may pay or the fact that it is a bull market.
"Many investors opt to sell part of their holding when a company’s shares double or triple, which allows them to lock in gains"
If growth slows down at what was previously a fast-growing company, it may be that its growth rate has reverted to the mean because there is no prospect of increasing its market share.
If it isn’t innovating and driving into new markets under those circumstances, it may also make perfect sense to sell. However, it may also be a pause for breath before the shares move on to new heights. When in doubt, you can decide to sell off your shares gradually.
Indeed, many investors opt to sell part of their holding when a company’s shares double or triple, which allows them to lock in gains and reduce the risk of making a future loss. It’s all a question of judgment, requiring detailed knowledge of the company in question.
3. You find a better opportunity
Sometimes a better investment opportunity comes along, but there are some precautions to consider first
The final reason to sell is when a better opportunity arises elsewhere. Now, this is very tricky if the company you are selling has performed well and you understand its business.
Given that investors (both professional and private) often make mistakes, selling a winner too early and reinvesting the proceeds can be risky. It is a bit like pulling up a prized plant to put in a seed that you hope will grow bigger.
This move certainly shouldn’t be done on a whim simply because you’ve read a broker note that has a hugely inflated target price for a particular "hot" stock or because a contact has given you a tip.
"It isn’t sensible to sell a winning share because the consensus is that it has become over-priced"
Similarly, it isn’t sensible to sell a winning share because the consensus is that it has become overpriced. On that basis, Warren Buffett never would have bought Coca-Cola shares and investors in Tesla would have sold out long ago.
Deciding when to sell is one of the biggest decisions investors must make. Time spent examining your motivations and the prospects for the company should reduce the risk of making a costly error.
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