I wanted to talk on this topic long time back. But I didn’t. The only reason behind it was that I wanted that to come from you. A relationship that has a quality of ‘give and take’ lasts long and is profitable for both the parties.

We have done many presentations on when to sell and what companies investors should look for before buying. This is first time I am writing an article on one of my favourite subjects.

Within this blog I will be talking about many companies as examples. Please do not interpret them as a buy or sell call from Valueoperations and take actions as they might be not relevant for today.

Most of the analyst and brokers talk with conviction that this is the right time to buy, accumulate and hold strategies and they prepare a report of few pages to support their call. They also come out with ‘sell’ call but few research pages and that conviction is not reflected. More of it looks like a nervous call being spoken loud on loudspeaker.

There is an old saying that you do not make money in stock market unless you have sold them. What do you think? Let’s go one year back in the past, how many of you owned SBI shares during that time. In late October and early November 2010 SBI was trading at Rs 3,400. Today it is trading at almost half of its price and it still looks like will go further down.

What if I say to you that it will take another 3 or maybe 5 years for SBI to reach back to those levels? Imagine people who have bought them at Rs 3,400 levels and they have not sold it yet, do you think they have lost any money? If you ask me, yes they have lost money. They have or will loose money by either booking losses or by waiting for the right time sell.

What I think is that you actually make money when you buy. The five strategies about when to sell, that I will disclose here will only make sense if you have bought the shares at right time. And when I say right time, I mean at great discounts to its intrinsic values.

Many of us believe that holding a company for few years is good or I have noticed that people talk about giving some time (3 years and 5 years) for company to outperform or turn their losses into profits. Warren Buffett quoted once that time is only your good friend if you have invested in good company or else is the biggest enemy if you have not.

1. The performance of the business declines

I have mentioned it before too that an extraordinary businesses are the one with competitive advantage, high rate of returns, little or no debt, strong cash flow and bright prospects.

These are the variables that every investor needs to keep an eye on in which they have invested. If you see any variables decline then it is time to move on from that company to something better.

Look at the table below:

Reliance Industries

Year 2007

Year 2011

Contributed Equity

63,967 Crore

151,540 Crore

Profits

11,943 Crore

20,286 Crore

Debts

27,826 Crore

67,396 Crore

ROE

21%

14%

Reliance Industries is considered as a blue chip company but as per Valueoperations definition, it is not. We rate this company as B1. In last 5 years, one third of its profitability has been lost. If you would have invested in this stock 5 years back (1st December 2007) then on absolute terms you would have made only 11% return factoring split. It is far ordinary return even compare to bank rates.

So avoid the companies whose performance is at decline, who are less profitable then they were before.

2. When value of any business declines

If you have read my article, “Ben Graham, Warren Buffett, Charlie Munger and Valueoperations” and if you believe in Ben Graham theory that in short run market is like voting machine but in long run it is weighing machine, then you would also believe when we say that “price always follows value sooner or later”.

So when you believe in that theory and if you just keep focus on the value then is it not worthwhile to invest in only those companies whose value is increasing?

Bharti Shipyard

 

The graph above is of Bharti Shipyard (B2) and the red line is the actual intrinsic value of the company in those years. After 2007, every single year the value has fallen down still within that 5 year period we can show you list of analyst and brokerage houses have given a buy call for this company.

Avoid the stocks where you evidence value is depreciating. As price always follows value, you won’t get healthy returns from depreciating value assets.

3. When price rises well above the value

The deviation or flip and flop of the price are sometimes too big. Again if you believe in the Market allegory of Ben Graham you would understand what I am saying. If price of any company is trading at expected future value in three years of the company we liquidate all of our positions in that and book profits and look for another opportunity.

Siemens India

Siemens India is rated as A1 Company by Valueoperations. For the last one year as per our model the company price was trading at premium and around forecasted 3 years value.

The performance of business is declining because management is retaining profit and investing at low rate of return and that is damaging its profitability. That is impacting straight away to its value and its value has declined from last consecutive 2 years without impacting much to its price.

In 2003 annual report to shareholder Buffett wrote:

“… I made a big mistake in not selling several of our larger holdings during the Great Bubble. If these stocks are fully priced now, you may wonder what I was thinking four years ago when their intrinsic value was lower and their prices far higher. So do I.”

 

In 2006 Buffett sold its investment in PetroChina for $4 billion. He purchased 1.3 percent of PetroChina shares for $488 million and remained invested in this company for just three to four years. In 2007 annual chairman’s letter to shareholder he mentioned that he sold it because he thinks that the market value had risen to what he thought it was worth. In this case he didn’t even wait for premiums.

So it is unto you when to sell and what appropriate time you feel to sell. It all depends on your goal and ambition to sell at intrinsic value or at 10% or 20% or at premium of 3 years intrinsic value.

4. When value of business is not rising at satisfactory rate

As a value investor we want you to concentrate on value of any business. If value of the business is not rising sufficiently then it is better to sell that and move to something better opportunity available. Let me give you example, if the shares of ‘ABC’ company are trading at Rs 130 and intrinsic value is Rs 100 and next years intrinsic value is expected to be Rs 110, followed by Rs 122 then the decision to sell at Rs 130 is simple one. You would have to wait another two years for your value to reach at those levels.

There is no enthusiasm to stay invested in company whose intrinsic value is not rising substantially to keep you invested, specially when it is trading at premiums to 3 year forecasted values.

5. You found something superior

As you build your portfolio, you will generate additional funds to invest further. The first opportunity that you had invested might not be that attractive now. The price at which they are trading might not justify you to even sell those stocks. Over a time you will have a portfolio were you are fully invested and some of those investments might be inferior to new opportunity available. Normally in that scenario I would prefer to sell the least attractive holdings and get into new opportunity.

This strategy was demonstrated by no other than Buffett when he sold shares in Johnson & Johnson to raise funds to participate in the recapitalisations of Goldman Sachs and General Electric.

But be careful that you don’t fall in the trap that Peter Lynch, fund manager and author of ‘Beating the street’ described as ‘pulling out the flowers and watering the weeds’.

If you follow our approach of stock selection as to invest only in A1 companies and only those A1 companies whose intrinsic values are increasing every year and are trading at great discounts then you won’t miss any great quality stock to own and avoid weeds as Peter Lynch described.

The above five list of reasons to sell is offcourse, not exhaustive. There are many other reasons for selling and you can adopt your own rule while considering selling. For example, Benjamin Graham advocated selling when the share price rose by 50% or two years after purchasing, whichever came first. Adopt your own strategy and rules for selling as suited to you.

Many people prefer the approach of Buffett to buy and own shares for long years. Outside Berkshire Hathaway, Buffetts buying and selling is far more frequent, and I have noted him saying it was a mistake not to sell some holdings under certain circumstances.

If any of the factors listed above are evident in your portfolio, then it might be a time to call your broker and sell the shares to someone who disagrees with you. In all circumstances proceeds are safest when deposited in the bank rather than invested in inferior stock.