Thursday, 30 August 2012

Sell your shares when they hit your target price

Whenever you buy shares you should have evaluated what price you think these shares are worth.  Typically you should buy these shares at a discount to the valuation equivalent to the rate of return you wish to achieve. It should also have a margin of safety (an idea first espoused by Benjamin Graham) which allows you to be wrong in some of your assumptions (or allows for unknown factors)

Note that this valuation will continue to change as new pieces of information become available.  As companies report their results, or corporate actions or as your the investment and regulatory and business environment changes around them the valuation of the company will change.  Likewise you should keep changing what you think the target price is worth to take into account all information that you think is relevant.

What will happen in many cases, is that when you have picked the right investment the market will eventually see what you saw earlier and the price will go up as a result.  Sometimes the market sees more than you do or perhaps becomes over-enamoured with a stock or thinks that it is a potential as a buy-out candidate and the price will run well past what you think it should sell at.

At this point - you should SELL

And trust me when I say this - this is one of the hardest things to do.  Your investment bet has come off and you have the gain you envisaged when you made the investment (sometimes a lot more as the stock price has run well past this point) but you do not want to sell because there is something inside all of us that says - "but what if the price continues to rise?".

The FEAR of missing out totally outweighs our rational mind that says what we should do is take our gain and be happy that we made the right investment decision.  We are also misled by statements taken out of context such as Warren Buffett's oft quoted saying that "We intend to hold our stocks forever". 

While this should be true if the stocks never reach the valuation potential, Warren Buffett also often talks about Mr Market, and the fact that Mr Market is irrational and offers you great deals from time to time.  The necessary counter side to Mr Market is that he offers you great deals for the stock you already own (i.e. the market is paying too much).  This is when you should sell the expensive stock and go look for opportunities to buy cheap stocks.

It is often hard to make the sell choice because:
  • The stock gains value a lot quicker than you expect: 
    • When it gains value that quickly we often think that we have missed something or there is this weird feeling that we have not done our investment dues in terms of time the stock is held 
    • Because of the vagaries of the market, it could be that you just entered at exactly the right time 
    • You should not be put off because the market is offering much more than you expected in a short period of time
  • The stock is subject to takeover rumours: 
    • I have done a post on this before
    • The argument I raised at the time was that if you are the least informed person in the market then the risk is that you sell too soon to others who have more information. 
    • However if you have no more information than the market and the stock has done exactly what you expect it to and more then holding onto it is essentially a gamble that the rumours are true. 
    • You may want to do this but make sure you are honest with yourself when you do it
  • We do not know what else to allocate the investment money to: 
    • This is a problem I have been facing more and more recently. 
    • As a lot of my investments are paying off I find myself sitting on bigger piles of cash as I have not found more homes for this cash.
Although these are all valid considerations however if you have done your research, are up to date on what is going on with your investment and you still think the market is pricing it too high then you should sell and be happy with your gains.  If you can - avoid seeing what happens next.  It may be that the stock goes up a lot more.  But you have made the gain you set out to and that should be your only consideration.

Other Posts you may like:
When to sell you shares into takeover bids
Investment psychology: Follow your convictions
Book Review: The Intelligent Investor by Benjamin Graham

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