I first got to know the name ‘Philip A. Fisher’, when I was shopping for materials on investments at a local bookstore some years ago. At that time, I recalled that I had flipped through his classic work, ‘Common Stocks and Uncommon Profits’, read through tens of pages and found it to be overwhelming as it was wordy. As a result, I decided to buy other books which I was confident in finishing them.
Today, after tens of books and now having a stock portfolio, I decided to buy his book and challenged myself to read his work. As I write, I read a few chapters in his book and had found new appreciation for his philosophies on investing. One of the simpler chapters he wrote is on selling a stock, where he had pointed out his investment objectives and examined 5 common reasons to sell a stock. They are as follows:
Fisher’s Investment Objectives
Fisher was a growth investor. He bought and accumulated growth stocks and he held them for the long-term. From Fisher, I’ve learned that if we invest in stocks that are fundamentally strong and they keep on growing in sales, profits, and as well as operating cash flows, the idea is to keep them and never sell.
So essentially, Fisher’s plan is to buy stocks to hold, not selling them for ‘profits’ in the short-term.
Reason 1: Mistakes
Let me illustrate.
For example, let’s say, you’d bought ABC Ltd, a fundamentally poor stock, out of greed and speculation. Then, you had realized that it was a mistake and learned that stocks should be invested based on their fundamentals. So, the question is, ‘What should you do with your shares of ABC Ltd?’
Should you sell them off and realize their losses?
Or, should you keep them until their prices climb back to your purchase costs?
From Fisher’s writings, I learned that it is wiser to sell off ABC Ltd than to hold it as the capital recouped from ABC Ltd could be reinvested into stocks which may deliver consistent growth in revenues, profits and operating cash flows over the long-term as their business fundamentals are so much greater than ABC Ltd.
Therefore, the first reason to sell a stock is when we make a mistake in buying it in the first place.
Reason 2: Deteriorating Business Fundamentals
Sometimes, this may happen.
For instance, let’s say, we have M Ltd, a fundamentally solid company that has a portfolio of traditional media businesses in a certain country. We learned that it had market dominance and generated continuous growth in earnings in its past years. Hence, we bought M Ltd’s shares.
But then, after investing into M Ltd, things changed.
People switched from traditional media to consuming online content. M Ltd did not keep up and started to see a fall in sales, profits and operating cash flows in its traditional media businesses. So, it no longer is a fundamentally solid stock.
In this case, the disposal of M Ltd’s shares is warranted.
Similar to selling off stocks bought out of mistakes, the capital recovered can be reinvested into stocks with better fundamentals so that wealth can be built and accumulated continuously over the long-term.
Reason 3: To Capitalize on Better Investment Opportunities
Let’s assume we invested into Stable Inc, a fundamentally solid stock in the past and it had delivered dividends and some capital gains ever since. Then today, as I write, we found Super Inc, a company that could grow faster than Stable Inc in the future. So, the question is, ‘Should we swap Stable Inc for Super Inc?’
From Fisher, I discovered that this is warranted in theory. However, in practice, I learned that Fisher cautioned against this because we could misjudge Super Inc and risk swapping what is working today for what might not work tomorrow. So in this case, I would say that the share sale here is less urgent than a disposal of shares due to mistakes (Reason 1) and deterioration in businesses (Reason 2).
Reason 4: A Bear Market is Coming
Fisher commented that stocks should be invested based on their fundamentals, not based on where the general stock market would be heading in the future. It is also helpful if investors ignore recommendations and comments for decisions related to investment matters.
Some may view that it is wise to sell off fundamentally decent stocks before the market crashes. This is so that they could buy them back at lower prices. But, in Fisher’s observations, the argument is, ‘Who knows when exactly a crash would happen in the stock market?’ For most people, these are just mere guesses.
In addition, let’s say a person sold off a good stock in fear of a market crash and indeed, the market crashed, causing the price of that particular stock to decline from his selling price, the question is, ‘Will he buy back his stock at a discount?’. Well, for Fisher, he observed that not many people would do so as they fear the stock could actually drop lower as no one really knows where the bottom lies in the future. So, what sounded intelligent may not be practical in psychology.
Thus, it is more practical to just focus on a stock’s business fundamentals, make sure that it could deliver consistent growth in profits in both bull and bear stock markets, and just hold onto them for the long-term.
Reason 5: The Stock Becomes Overpriced
While this seems logical, the question is, ‘How do we determine if the price of a stock has become ‘overpriced’?. What is our basis of measurement?
From Fisher’s writings, he would focus on a stock’s growth prospects over price. It did not make sense for him to sell stocks which have ample growth initiatives, just because their current P/E Ratio are high. Thus, growth is of preeminence. It is more important than P/E Ratios.
For example, we have Growth Inc., a retailer with 500 retail stores that made as much as $100 million in earnings or $1 in earnings per share (EPS). Presently, its stock price is $30 a share, thus, working out to have a P/E Ratio of 30. So, in this case, do we sell Growth Inc. as we find its P/E Ratio to be relatively high?
Now, before you do, what if I offer you a couple more information?
What if Growth Inc. had revealed that it intends to expand its stores to as much as 1,000 outlets for the next 3-5 years? Coupled with sales growth from existing stores, Growth Inc. could grow its yearly earnings to $200 million or $2 in EPS in 5 years from now. Will this impact your decision to sell off Growth Inc? You bet.
Hence, it is more practical to assess business growth before selling off a stock.
Conclusion:
So there you go, the 5 common reasons to sell a stock. From Fisher, I’ve learned that the valid reasons to sell a stock are:
Reason 1: Cut losses from investment mistakes.
Reason 2: Deteriorating Business Fundamentals.
The lesser reasons to sell a stock are:
Reason 3: Better Investment Opportunities Arise (debatable)
Reason 4: If a Bear Market is Coming or Has Arrived.
Reason 5: Solely if the P/E Ratio of a Stock is High (overpriced).
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