Some investor-favourite stocks have fallen more than 50 per cent from their all-time highs. I am sure we now wish that we had sold these stocks at the right time as we are staring at the losses.

Well, most investors, despite spending many years in the stock market, do not master exit strategy. Often they end up selling a stock at the wrong time.

The biggest reason that investors desist from selling a stock is: what if the scrip goes up after I sell out? That is the biggest pain point. It is like buying a mobile with a fear that next day a new model will be available at a lower price.  

How do we fix that? First the basics:

It is not the buying price alone that decides your quantum of profit or loss on your investment, but also the timing of your exit. Investors don’t exit stocks despite sitting on tonnes of money as they become greedy. The result? They end up holding the stocks for a very long time.

A long holding period does not necessarily result in capital appreciation, but may lead to huge losses. Those who bought GVK, Unitech, Financial Technologies or Suzlon (to name a few) in 2005 and are still holding them will relate to this.

In the investor guru books, we have all been taught that one should buy good quality stocks for long term investments. Agreed. But holding stocks for the long term is no guarantee of return. Those who had bought Suzlon or Reliance Communications in 2007 and are still holding them can vouch for the same. Remember, these companies were either part of the indices or blue chips with wide coverage from analysts and fund managers.

The Mahabharat story is a testimony. While Arjun knew how to enter and exit the Chakravyuh, his son Abhimanyu knew how to enter the Chakravyuh, but had no knowledge of how to break out of it. He lost his life in the battle. Many investors are like Abhimanyu. They get killed on their exit strategy. They know how to enter the stock, but they hardly know when to exit it. The key to be successful in the stock market is to be like Arjun—who knew how to enter and exit.

Most market experts advise what to buy, rarely does one tell you when to sell. Hence, what you have bought based on tips remains with you forever in the portfolio. Human nature is to hold on to loss-making stocks forever. For some unknown reason, investors are quick to act on the profitable stocks, but slow to act on the loss-making ones. They don’t realise that loss-making investment is not going to yield any returns over a long period of time.

How can one be Arjun of the stock market?

Let me give you a few guidelines that I follow whenever I wish to exit a stock. I apply these guidelines not only for profitable investments, but also to loss-making ones.

I am outlining four factors that I use for my ‘sell’ decision.

1. Sector fancy

The sector premium decides what PE a company will command. In the 2003-2008 rally, we had seen infra stocks having PE expansion as the sector was the flavour of the season. On similar lines, from 2009 to 2016, the pharma sector was the flavour of the season. Companies such as Sun Pharma saw its PE expanding from 12 times in 2009 to close to 40 times (it went even higher) or Glaxo Pharma whose PE expanded from 21 times to as high as 80 times. With EPS expanding too, it pushed up share price many times. But pharma sector lost its fancy somewhere between fag end of 2016 to beginning of 2017. In the last two years, the pharma index underperformed by a huge margin. Investors are not willing to pay the same PE that the pharma companies once used to command. Many investors are holding these stocks thinking that they would make an exit with a profit. I am not going into the merits or demerits of investing in pharma companies now. The point I wish to highlight is that it is a big fallacy when investors believe that the fancy for the sector would remain forever. They hardly realise that once a sector loses its fancy, it takes a very long time for the sector to make a comeback. Infra stocks were the flavour between 2003 to 2008, but these stocks did not participate when the Sensex touched all-time high. Investors had enough chance in 2008 to move out from infra companies, but they thought this would be a temporary phase. Since they had seen higher prices for the stocks, they were not willing to sell the shares at 20 per cent discount from those higher prices. They held on to the stocks in the belief that the stocks will bounce back. They never did. Many companies are now quoting at 5 per cent of their peak levels. What is more frustrating is that the indices moved up in the interim, creating a double whammy for the investors. I would normally make an exit the moment I realise that the sector is losing its fancy. It is not easy to find out at an early stage whether or not the sector has lost fancy. But once you realise that it has, it is better to move out without delay. One of the ways to find out whether or not a sector has lost fancy is when the stocks from the sector stop touching 52-week highs. On the other hand, companies that move down by at least 20 per cent from their highs without any obvious reason do suggest that the fancy for the sector is on the wane.

2. Company’s fundamentals start showing fatigue

Every investor loves a company that reports smart growth. That company also commands better premium too from the investors. My antenna goes up when a growing company suddenly stops reporting growth numbers for at least two consecutive quarters. In that case, I would book profits. It is very unlikely that the company will command the same respect from the investors as it used to. So, even if the company’s EPS improves, there is no guarantee that the company will give capital appreciation. Just take the case of Sun Pharma, which came out with excellent quarterly financial numbers on 12th Feb. The scrip did not see any re-rating. Sun Pharma has been struggling to report consistent growth in its financials since December 2016. Since then, it has been underperforming.

3. Corporate governance issue

I have low tolerance level on the issue of corporate governance. The moment there is a cloud over corporate governance in the company, I would exit from the counter. What is crucial to watch is how the management responds to the issue. Despite management’s clarification, if the scrip refuses to rise, it shows that the market is in no mood to give benefit of doubt to the management. Remember DHFL, Financial Technologies, Vakrangee, Manpasand Beverages. These companies came under scrutiny due to corporate governance issues. Their managements clarified, but the scrips did not move up. This despite nothing has been proved against them yet. It is highly unlikely that these companies will see the previous peak levels in a hurry. Some may never touch those levels again.

Normal investor’s tendency is to ignore the corporate governance issue and hope that the share price will bounce back. Some are more adventurous and buy more shares at the declines, thinking it is a good opportunity to buy the same.

Just for clarification, I did not have any of the companies mentioned above in my portfolio.

4. The Golden Rule

Never look at the share price after you sell the stock. It’s a wasteful exercise. This exercise will make you sad. I never look at the stock price once I move out for at least six months, unless there is substantial news on the company that forces me to relook at the company. At that time, I don’t see whether the scrip is quoting above or below my sell price. I reassess the company at that point of time to take a call on the company.

On many occasions, it might happen that the share price moves up after you exit. Don’t bother. There is a high probability that you would not have sold the shares at the price when it peaked. You would have seen the share price going high, only to see it falling substantially, giving you a big regret.

I would suggest you follow the four points mentioned above rigorously. There is a possibility that this strategy may not always work. In some instances, you may see the scrips moving up substantially after you sell. But that would happen otherwise too. No one can sell shares at the peak price consistently. Don’t fool yourself that you would be able to.

Profit booked is more important than book profit.

If you don’t agree with my views, please feel to write to me on support@marketsmojo.com or post your comments below.

 

Sunil Damania

@sunildamania

Disclaimer: This blog is only for education purpose. We don’t give buy or sell call on any company. All investors are advised to do their independent research and/or consult their financial advisor.