Six reasons to sell your winning stocks
After selling a ‘winner’ to realise a profit, many investors feel frustrated when that company’s share price continues to soar. The prospect of foregone gains can be exasperating, leaving investors wishing they’d waited until the price had peaked before selling.
However, this is incredibly difficult to achieve in reality. I can count on one hand the number of times I’ve sold a stock when its share price had hit its high.
So, when you own a stock that has performed strongly and it looks like it will continue to perform well, when should you sell? As an active investor, as opposed to a buy and hold, determining when to sell shares is a critical part of our investment process.
Our approach means we have a tendency to sell before a share price peaks. One example is Ainsworth Game Technology (ASX:AGI). We started buying AGI shares at around 30 cents and selling them at $2.04 before they reached a remarkable $4.79.
Outlined below are some important factors that form part of our investment methodology and inform our decisions to sell our investments, including our winners:
1. Invest with an exit strategy
At the time we invest in a company, we ensure we have a strategy to exit our position. As part of this strategy, we have a clear valuation target for the securities and identify a catalyst we believe will re-rate that company’s share price.
In theory, once it has hit our target valuation, we sell. In practice however, this scenario only plays out approximately 5-10% of the time. More commonly, we identify an additional investment catalyst we think will generate further upside and adjust our target valuation accordingly. Such catalysts may include an earnings surprise, or changes in management, regulatory environment, or industry structure.
2. Realise when the company is ‘discovered’
Many companies we invest in are initially not well known or understood by the market. This can create a significant opportunity: once the broader market discovers that company’s ‘story’ and recognises its value, its share price may climb. This is frequently a signal to sell as further share price growth may then be constrained. Two factors that indicate a company has been discovered are 1) when large institutional investors join its share register and/or 2) stock analysts initiate coverage of the company.
3. Watch for a significant change in outlook
When circumstances or events have an adverse effect on a company’s outlook, this is a compelling reason to sell a winner. This is particularly important in the case of small to mid-cap stocks as they are more prone to be affected by one-off events and their share prices can be more volatile. An intimate understanding of a company, its operations and commercial drivers is crucial to identifying such circumstances or events that may impact the business’s future prospects.
Until early last year, there was considerable enthusiasm in the market for companies leveraged to Chinese consumers and their demand for Australian products, such as vitamins and infant formula. At the time we owned Blackmores (ASX:BKL) and The a2 Milk Company (ASX:A2M), which provided excellent exposure to this trend and both companies had experienced strong share price growth. Based on our research, it appeared there was considerable regulatory risk building for these companies because of changes to online imports foreshadowed by the Chinese Government.
While the market’s support for Blackmores and a2 Milk remained robust, we decided the emerging regulatory risk represented a major catalyst to sell so we sold out of both companies. Both remain well managed businesses with strong brand names.
We often form a negative view of a company when the majority of the market is still enthusiastic about its outlook. In our experience, it pays to take a contrarian approach and, as Warren Buffet has cautioned, be fearful when others are greedy.
4. Manage the portfolio re-balancing
When a stock has experienced a meteoric rise, it can quickly become a large proportion of a portfolio. Therefore, selling (or at least selling down) a winner can be a prudent risk-management measure. In the case of small and mid-cap companies, which can be relatively less liquid, we often sell down a position when short-term liquidity is created, for example, after a results announcement.
5. Let winners run
In our experience, there can be wisdom in the often-cited adage, ‘let your winners run’. In some instances, a stock has reached our target valuation and there is no further identifiable catalyst to re-rate its share price. However, if we believe there is a degree of momentum in the market, we will maintain our position for a period.
When accommodation operator Mantra Group (ASX:MTR) made its market debut in mid-2014 at $1.80 a share, we invested and set a target valuation of $2.30. When Mantra hit our target price within a few months, we felt the market’s enthusiasm would drive its share price higher given there was plenty of evidence that the tourism sector was improving due to the lower Australian dollar. We revised our initial target, maintained our position and eventually sold our Mantra shares at an average of $4.25 earlier this year.
When we started buying a2 Milk at 52 cents, our target price was 75 cents. We felt confident the company would announce an earnings upgrade due to demand outstripping supply. This belief was based on my personal experience of trying to track down a tin of the company’s infant formula only to find there was a considerable shortage of supply. a2 Milk subsequently announced an earnings upgrade which surprised the market and saw their share price surge, surpassing our target. We continued to ride the momentum, ultimately selling at $1.68.
Proximity to the market and an understanding of the psychology of its participants can help in assessing whether there is momentum that could drive a company’s share price. When a stock reaches a 12-month high, this can be a tangible measure of such momentum. Conversely, a 12-month low can indicate the company has lost the market’s support.
6. Don’t fall in love with a stock
Depending on the investor’s objectives, it is important to consider a range of factors when selling a winner. Establishing an exit strategy, developing an in-depth understanding of the company, and insight into the market’s view of the stock is imperative.
Above all else, avoid forming an emotional attachment to an investment. Having spent considerable time and energy researching and understanding a company, its industry and its management, it can be difficult not to fall in love with a stock, particularly a winner. Yet an emotional attachment can inhibit your ability to properly evaluate the company and its prospects.
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