For most of us, deciding when to sell is a lot harder than deciding when to buy. It’s not a subject that gets much attention, largely because it can depend on individual circumstances–when you bought the stock, how big a part of your portfolio it is, etc. Also the sell calls are not really high – after all nobody (read management) will really want to pay for such a report, right?

Still, there are some solid rules for when selling is a good idea, and for when it’s not.

Did You Make a Mistake?

In other words, did you miss something when you first evaluated the company? Perhaps you thought management would be able to pull off a turnaround, but the task turned out to be bigger than you thought. Or maybe you underestimated the strength of a company’s competition, or overestimated its ability to find new growth opportunities. No matter what the reasons, it’s rarely worth holding on to a stock that you bought for a reason that’s no longer valid. If your initial analysis was wrong, cut your losses and move on.
I did this several years ago with a shipyard company (heard of Chokani International?). My growth expectations turned out to be way too high, because the India for ship building and maintenance boom that I expected did not happen! I was down quite a bit on the investment by the time I figured this out, but I sold anyway. Good thing, too, because the shares subsequently plunged to penny-stock territory. I recently (about 3 years ago) bought shares of GMR Infrastructure for Rs. 71 – thinking of the Infra demand in the country, the Delhi and Hyderabad airports…etc. (breaking my own rule of NOTHING from Hyderabad). However when I quickly reduced my exposure – and lost just a couple of bucks. Then of course it plunged to 20 or even lower.

Have the circumstances changed?

I bought a piece of shit – Crest Animation – it was supposed to be the Infosys in the Animation space. Then the prices went down a little, added more, because a brilliant merchant banker joined the board. I had no business holding the share once he left the board! (price had gone further south by then)..then reluctantly (reluctance to acknowledge OWN mistake)…I did sell, but had bled a lot by then. Mistake? trusting the shitty management.
Have the Fundamentals Deteriorated?

After many  years of success, that raging growth company you bought has started to slow down. Cash is piling up as the company has a tougher time finding profitable, new investment opportunities, and competition is eating away at the company’s margins. Sounds like it’s time to reassess the company’s future prospects. If they’re substantially more grim than they used to be, it’s time to sell, no matter what the stock price has done since you bought it. Companies which are in my portfolio and I keep worrying about this problem are Colgate, Ashok Leyland, Hdfc, – but I realized that in all these industries the equations do not change easily. Even ITC with all the new laws in cigarette sales, the margins do not fall off really quick. But one needs to be hawk eyed.
Has the Stock Surpassed Its Intrinsic Value?

Let’s face it: Mr. Market is a capricious individual, and sometimes he wakes up in an awfully generous mood and offers to pay you a price far in excess of what your investment is really worth. There’s no reason not to take advantage of his good mood. What you need to ask yourself is how likely it is that your estimate of what the company is worth could go up over time. If your estimate of intrinsic value is likely to rise, than it’s worth waiting out periods of mild overvaluation.

It is not always easy to ACCEPT that it has reached its peak. Take a look at Cholamandalam Investment and Finance. Not long ago I bought it at Rs. 60, thinking I would happily sell it at Rs. 300 in 5 years. Half way to the 5 year mark it is already at Rs.500 and I am holding almost the whole quantity – sold just 1500 shares enroute.

Generally, it does not take much in the way of a valuation premium to convince me to sell stocks with minimal economic moats. However, I am not so keen to sell stocks with wide moats. FMCG and Pharma in Indian markets quote at such a premium that one does not know what is the intrinsic value – so Pfizer, GSK, Colgate, Gillette, PnG, …etc. continue to be in my portfolio. NO clue when I will sell all these shares which have been with us for 3-4 decades.

Is the share now more than 12%* of your Portfolio? 

Any time one stock grows to become more than 10% of your portfolio, you should start thinking very carefully about how much risk you’re taking on–even if you still think a company has great prospects, it’s simply not prudent to allow it to take up too large a percentage of your portfolio. I learned this lesson the hard way a few years ago. I’d bought a few hundred shares of a small company called Mukand Engineering back in 1999, and five years later it comprised more than 20% of my portfolio. I sold some shares to lessen my exposure, but not nearly enough. As a result of my greed, I suffered more than my fair share of the tech downdraft. Sometimes we need to learn the hard way. (Ah yes this engineering company was masquerading as a technology company for a few years of its existence)

* create your own limits, I am happy with about 12-14% but sometimes break it and allow it to go to 16% in case of commodity stocks…

Of course, spreading your risks around applies to larger categories–such as sectors, groups, market caps, and styles–in addition to individual stocks. Any time you find that too much of your portfolio is in one area of the market, then you’ve probably got yourself some good sell candidates.