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It is not easy to invest in a company and sell at the right time to get the maximum return. Usually, selling the stock for maximum return on investment (ROI) is possible when the shares are purchased at a low price below the intrinsic or fair value of the share price.
Making a profit in the stock market starts by buying shares at the margin of safety. This is the fundamental of value investing; you need to analyse the company and its management and only buy it when the price falls below the intrinsic value and at a margin of safety of your choosing.
If you are not familiar with value investing, you should check two of our guides on value investing:
- Guide To Value Investing Strategy – Warren Buffett Style
- 9 Simple Steps To Calculate The Margin Of Safety
There is no perfect time to sell stock. You cannot predict exactly when the stock will hit its highest before selling. However, in general, the stock should be sold when that stock becomes extremely overpriced, when the company fundamentals have changed, or when there is a better investment opportunity that makes sense to take your money out.
Below is an explanation of those three reasons:
1- Selling when stock becomes overpriced
The stock market is unpredictable, and it is impossible to know when the stock will hit its highest or lowest. The best you can do is focus on buying a company whose earnings have increased over the years and a company you understand. If you purchase that company at an attractive margin of safety, you can sell the stock when it hits its intrinsic value (True value).
The intelligent investor always looks for a company that has the following:
- Moat: or competitive advantage to defend itself against competitors.
- High growth rates: that has an increasing trend.
- Excellent management: that takes care of its shareholders.
To make a profit, the purchase must be when the price is on sale (Margin of Safety). The ability to buy a stock at a sale price is possible because the market can sometimes overprice or underprice a stock, and it does not give you a fair value. You should never buy a stock at a high price because you will sell at a loss.
2-Selling when the company fundamentals have changed
The company can change its fundamentals. Not all companies can stay the same. Some changes can be obvious such as deteriorating business, getting acquired by another company, or losing the competitive advantage that makes it lose market share. In those situations, selling the stock is permitted due to the unpredictability of the company.
Other fundamentals are not so obvious and do not necessarily look bad such as a company diversifying and acquiring a new company or changing management. In any case, a change in company fundamentals means that the company is different to when you originally bought the stock. The best course of action is to re-evaluate the business or sell the stock if changes are severe and you no longer can understand the business.
In general, companies, at some point, can either be losing or booming. It is easy to spot a losing business. However, more than usual, it is difficult to identify a change in fundamentals. The following comprises of change of fundamentals that you should worry about, re-evaluate the business, or possibly sell:
- Diworsification: a booming business that decided to diversify and enter different industries. For example, a Tech company decide to get into the food industry.
- The merger of two companies: might sound good on the news, but this means the birth of a new company.
- Change in company type: for example, a fast-growing company that develops new products every year suddenly becomes a slow grower and stops producing new products.
- Change in management: buying companies depends on the management’s performance. If a company change its management, then you should re-evaluate the business. Management decides how the company operate. Therefore, you should research if the new management is acting for the benefit of the shareholders.
3-Sell for a better investment opportunity
If you are selling the stock for another opportunity, you admit that this business is not worth your money. There is always a better opportunity in the market; if you decide to put your money into a different company, you must ask yourself the following:
- Have you got everything you want from this current company?
- What advantage the new company has that this company do not?
- Are you buying the new company at an attractive price?
Active investors can fall into the trap of rotating their money in different businesses in a short time. Sometimes, it is best to sit on cash and not fully invest all your money. It is better than taking 10% or 20% from an existing company that has not fully matured. Or worse, you invest money you need to use soon.
The best way to manage your portfolio is to have spare cash you do not need and are not invested in the stock market, ready for a hot new opportunity. Cash as low as $2000 can be a good start.
Worst case: if you do not have any free money to invest, then it is time to go through your portfolio. Choose who you think has the least ROI.
