One of the main reasons why most investors are unsuccessful in the stock market is that they don’t know when to sell or liquidate their position in stocks from their portfolio. Some of the most common factors influencing this are investor biases. These biases are often influenced by psychological factors, which can adversely affect successful investing.
This is why investor discipline is key when selling a stock. The discussion on when to sell a stock will examine essential points that investors need to consider when selling a stock. The examples explored in the article will cover Singapore-listed stocks for the benefit of domestic investors.
1. Deciding on expected returns
One of the easiest ways to sell a stock is to determine what the expected return on the stock is before purchasing it. This should include the time frame for achieving the expected return, because achieving 10% returns annually on a stock is completely different from achieving 10% returns on a stock without a specified time frame. Typically, the time frame is a 12-month period or annually, but it can be adjusted according to the investor’s risk profile.
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This risk profile should include two key factors: the investor’s willingness to take risks and their capacity to do so. The willingness of an investor to take risks should not be based on the investor’s age and emotional inclination, but rather on how well the investor understands the business of the stock. For example, the willingness of someone who’s been in the banking industry for over 10 years to invest in DBS Group Holdings, Oversea-Chinese Banking Corp and United Overseas Bank should be higher than stocks in a different industry. The capacity of an investor to take risks should be based on their financial capacity, which includes factors such as financial obligations and non-investment-related income.
The higher the willingness and capacity to take risks, the higher the expected returns and the shorter the time frame to achieve these returns can be, but not necessarily has to be. The absolute lowest returns an investor should expect or plan for is to beat a selected benchmark. The benchmark chosen should be the best alternative after considering opportunity costs, such as a stock market benchmark, for example, the Straits Times Index, or fixed deposit returns. Because, at the end of the day, why invest in individual stocks when there are other alternatives which give better risk-adjusted returns?
2. Being disciplined when selling
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After determining the target price or expected returns of a stock, it is essential to stick to the price and not be swayed by market noise. For example, suppose an investor has researched and decided to buy Singapore Telecommunications (Singtel) because their assessment of the company’s intrinsic value is $6.00. In that case, they should set their take-profit price at $1.12 above Singtel’s current price of $4.88, which is roughly a 23% expected return over a one-year period.
The question is, when should the target price be revised within the 12-month period? Since Singtel does quarterly business updates and reports results half-yearly, these can be good intervals to reassess the fair value or intrinsic value of the company. Depending on how significant and different these updates and results are compared to the investor’s initial assessment of the company’s fair or intrinsic value, the target price or returns should be adjusted accordingly. Being disciplined is not about adjusting the target price in response to every available business update or news, but rather determining whether the updates or news are material enough to warrant a change in the fair or intrinsic value of the company.
To assist investors in determining whether an event is material enough for a change in the fair or intrinsic value of a company, only important events that were not accounted for in the initial valuation of the company should be considered. Having a checklist of this not only aids the investor in understanding the business better but also helps in determining when an update is drastic enough to warrant a change in target price or when to sell a stock.
3. What to do if you’re winning
If Singtel reaches $6.00 within the 12-month period, the disciplined investor should consider selling the stock and moving on to other investments. This is easier said than done, and precisely why investors lose money in the stock market: they fail to lock in their profits. One key consideration for an investor in this situation is whether there is another undervalued stock to invest in.
Let’s consider a probable scenario an investor would face after Singtel hits $6.00. Say an investor takes two weeks to thoroughly assess the intrinsic value of one company. After assessing five stocks, the fifth stock, which is Singapore Airlines (SIA), is considered undervalued by the investor. This means that the investor would only buy SIA after 10 weeks. An investor who is not fully disciplined would hold Singtel for this 10-week period and then proceed to sell it to buy SIA. The problem with this is that Singtel’s share price can fluctuate significantly during this period, exposing investors to unnecessary risk.
So, if you’ve won with Singtel, consider selling it entirely before the end of this 10-week assessment period. It is better to have the guaranteed 23% than potentially losing it all in this period. For disciplined investors concerned about opportunity cost, consider allocating the money to low-risk, short-term liquid investments, such as Singapore Savings Bonds, while searching for an undervalued stock. Alternatively, the investor could add to existing positions in stocks that are undervalued in their portfolio while searching for new ones.
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4. What to do if you’re losing
Let’s look at an exaggerated example. If Singtel drops 50% to $2.44 in a black swan event. Part of being a disciplined investor is to prepare for worst-case scenarios.
To do this, when assessing the fair or intrinsic value of a company, the worst-case scenario valuations should be noted. For Singtel, the $6.00 valuation is the midpoint of the worst-case and best-case valuations for the company. Let’s say the worst-case valuation is $4.00 and the best-case valuation is $8.00, so $6.00 is the midpoint. The disciplined investor would have their full stop-loss at $4.00.
From $4.00 to $6.00, anything below Singtel’s current price of $4.88 is critical. One way to manage this is to have three checkpoints between the worst-case price and the current price. The three checkpoints in this specific example are $4.66, $4.44 and $4.22. Every time the share price falls to these individual values, a reassessment of the stock should be conducted, ideally one that scrutinises the company further as the share price continues to fall.
At $4.66, find one more reason to support the investment case of the company. At $4.44, find two additional reasons to support the investment thesis of the company. At $4.22, justify and defend the investment thesis against red flags and bear cases against the company. At $4.00, revamp and redo the valuations of Singtel with as little bias as possible. If, at any point, justifying why the company is still undervalued becomes impossible, then it is time to sell the stock.
No excuses, no delay and no bias should be shown by the investor because sometimes even disciplined and diligent investors can be wrong, and it is important to acknowledge this and cut losses. Unfortunately, the markets for trading derivatives and options for Singapore-listed stocks are not as readily accessible yet as other stocks overseas, such as in the US, so instruments such as put options, which could be useful in this Singtel example, cannot be used to cut losses more efficiently.
In this example, a disciplined investor would not only have cut their losses completely at $4.00 but also would likely have put their money into another undervalued stock where they have a higher chance of winning and profiting. Remember, the upside for investing in stocks is technically unlimited, but the losses are capped, so it is okay to be wrong as a diligent and disciplined investor.
It’s still all about value
The key takeaway is that setting exact numbers and prices will make the investor more disciplined because it is something objective, tangible and visible to the investor, like a finish line for a runner.
Some of the individual points can be explored much further and will be done in subsequent articles in this series. Although this article only explores when to sell stocks, investors should also exercise caution and be diligent when buying stocks. Just because investors have a proper exit plan, doesn’t mean that they should dabble in anything and everything in the stock market — knowing how and when to buy undervalued stocks is equally as important as knowing when to sell them.
