This is a question that we get asked most by investors. It is a difficult question to answer. We believe that selling is of equal importance to buying.
Most time is spent by investors figuring out what to buy. Little time is spent figuring out what to sell. This is despite it being harder and of equal importance to buying.
The average lifespan of a company listed in the S&P500 has decreased from 67 years in the 1920s to 15 years today”–Richard Foster, Yale University.
John Ryder, the founder of Ryman Healthcare in New Zealand recently commented that of the top 32 companies on the NZX 50 in 1987 are without exception no longer part of the NZX in 2017, 30 years later.
Companies disappear. They go out of business, they merge, or they get overtaken by new market leaders. Compare the table below of the largest companies in the world by market capitalization in the second quarter of 2017 to the second quarter of 2010:
Only 4 of the companies on the list in 2010 make it to the list in 2017 and of those, Exxon has gone from number 1 to 10. Go back further to 1997 and only Exxon and Microsoft appear on either list. 10 years from now it is probable that these companies will rotate again. As investors, we want to own the best performing companies. If this is truly the case, then we have got to know when to sell and rotate into new leadership. This also identifies the risks inherent in a buy and hold strategy. Whether you are a short-term trader or a long-term investor there are three reasons investors will sell; To crystallise profits, cut losses, or to find better opportunities.
One reason to sell is to take profits. At some point to realise a capital gain on a stock an investor must take a profit. This point seems obvious and is quite easy in retrospect but in reality, it is easier said than done.
How often have you sold a stock for a tidy profit only to watch it double from the point that you sold it? Or how often have you wished you sold at the previous peak, only to hold on hoping it will get back up? Taking profits is hard, picking the peak like picking the bottom is rare.
Another reason to sell is to cut losses. This is essentially admitting that you are wrong. Nobody knows what is going to happen in the stock market and in business tomorrow. Not even Warren Buffett is right every time.
For this reason, investors must be able cut losses to protect their capital when they are wrong. The question is, how do you know when you are wrong? How many times have you sold at the bottom only to watch the stock turn around and go back up? How many times have you interpreted a piece of news as detrimental to the stock and sold only to watch the company shrug off the bad news?
We have all been in the situation where you buy a stock that does nothing for a couple of years. All the while the market or other stocks you were looking at moved strongly. It is always important for investors to identify when there are better opportunities and allocate capital appropriately to these situations.