As an investor, you should be willing to sell shares in a company should you believe its best days are in the past. You will inevitably get things wrong from time to time and/or the investment case can change and, in these circumstances, you must summon up the courage to click the sell button.

Buying low and selling high is the key objective when it comes to investing in shares, but even experienced and professional stock pickers get this the wrong way round, buying high and selling low. Many investors stick with poorly performing stocks in the hope they will recover, while others panic and sell great businesses when their shares are caught up in wider market drawdowns with the aim of avoiding larger losses when a sharp rally could be right around the corner.

Checklist: times when you might want to sell a share

- Has your confidence in the company changed?

- Has the stock become overvalued?

- Is this a suitable time to take profits?

- Is this a classic ‘falling knife’?

- Have key management figures departed?

- Are financial metrics worsening?

- Has a transformational acquisition increased risk?

- Have you identified better opportunities elsewhere?

WHY IT PAYS TO HOLD YOUR NERVE

Investors are living through a volatile period for stock markets, with the past five years alone punctuated by political turbulence, a pandemic, war in Ukraine, red-hot inflation and rising interest rates. But as the chart below shows, skittish investors who sold their equity holdings when global markets plunged on the arrival of Covid and the implementation of lockdowns in early 2020 may have rued the decision, as they missed out on strong subsequent rallies.

A plunging share price isn’t an automatic reason to sell a great company, so long as the investment case remains intact and the business has just encountered a short-term hiccough.

Take the world’s biggest retailer, Walmart (WMT:NYSE), which we identified as a Great Ideas selection in February 2021 at $145.8 in the belief its strong value proposition would deliver further market share gains.

A matter of days later shares in the groceries-to-general merchandise goliath sold-off on fourth quarter earnings miss (18 February) and accompanying warning sales would moderate, but we urged readers to keep buying at $138.30. Admittedly, the shares provided a bumpy ride as May 2022 witnessed Walmart issuing weaker-than-expected earnings and a profit warning, then a further alert in July 2022 with inflation forcing customers to cut back on discretionary purchases, followed by downbeat guidance in February of 2023.

Yet despite these short-term setbacks, shares in Walmart are currently trading 5% above our original recommendation level at $152.60, the share price buoyed by consistent market share gains, progress in reducing its bloated inventory and returns of capital including dividends and share buybacks, while the long-term outlook for the retailer remains positive.

Stories such as Walmart serve as a lesson to keep your emotions in check and reassess your investment thesis when a bad spell strikes a company you have previously backed. Just because a share price has fallen sharply doesn’t necessarily mean you should ditch the stock.

Instead, you should ask yourself some tough questions, such as has the fundamental investment thesis changed, are you simply reacting to a share price fall, and is it worth monitoring the stock a little longer to see if your continued confidence is justified? To make this process easier for readers, we have provided a simple decision flow chart.

WHY YOU SHOULDN’T BE AFRAID TO TAKE PROFITS

‘No-one ever went broke taking a profit’ is a quote attributed to one of the Rockefellers and to illustrate the point, here is a profit-taking example from one of our recent Great Ideas selections.

We originally flagged On The Beach (OTB) at 129p in July 2022, having identified that shares in the online package holidays in the sun seller were trading at their lowest valuation in the seven years since listing on the stock market. We argued this had created an excellent opportunity to invest in a financially strong and ‘fundamentally sound’ business with good longer-term prospects.

Initially it looked like we had gone positive too early, as the shares sank to an all-time low in late September 2022 before roaring back along with a revived travel sector to leave our trade more than 37% in the money at 177p.

We then urged readers to take profits in February 2023 following some mixed comments on trading and on concerns higher spending could weigh on short-term profit margins. Our timing on selling was nigh-on perfect, as we missed the share price peak by a matter of days, and the shares have subsequently slipped back to 127.2p.

DON’T CATCH A FALLING KNIFE

‘Don’t catch a falling knife’ is another well-known investing adage, which means a plunging share price may drop further. Trying to catch a knife that is falling is a dangerous thing to do and can lead to portfolio bloodshed, as this example demonstrates.

We recommended Avon Protection (AVON) at £26.94 in July 2021 in the belief the protective equipment firm was moving past its problems, but sadly the military equipment business’ alarming run of profit warnings continued.

Unfortunately, we doubled down on the recommendation in August 2021 after the company delivered its first revenue warning, but the situation worsened in November 2021 as Avon revealed new delays on orders for its body armour business and announced a strategic review of the division. The news prompted us to duck out at a 60% loss, having sold out too late.

LESSONS FROM THE PROFESSIONALS

Adam Avigdori, co-manager of investment trust BlackRock Income & Growth (BRIG), views having a rigorous sell discipline as a core part of managing risk and highlights three key situations when he considers selling a share. The first is when a share has reached its target price.

‘Meeting a price target doesn’t mean moving out of an entire holding completely, but it may result in the selling of a segment of a holding to crystalise a portion of the gains or using it as an opportunity to evaluate the company fundamentals and its future prospects,’ he explains.

The second scenario is if new public information becomes known, whether company specific or relating to the broader economy, which undermines a fundamental part of the investment case. ‘We are constantly analysing our portfolio to check the validity of our holdings’ investment theses, and we will act if those theses have weakened,’ he points out.

Thirdly, added information ‘may also have a positive impact on our investment theses, meaning we may want to build on an existing holding or start a new position, when we find a new idea that has a stronger case for inclusion in the portfolio.

‘Inevitably, this may mean we reappraise and reduce other holdings, to ensure our best ideas are properly represented.’

Also chiming in is Eric Burns, chief analyst at Sanford DeLand, the manager of the CFP SDL UK Buffettology (BF0LDZ3) and CFP SDL Free Spirit (BYYQC27) funds which follow ‘Business Perspective Investing’, a quality-focused approach championed by Buffett and Charlie Munger.

Burns says this Business Perspective Investing process means there are only a very small number of reasons why Sanford DeLand would sell a holding and that decision is ‘driven by what’s going on at the business itself rather than often extraneous factors such as movements in share prices.

‘Remember that the market is there to serve you, not to instruct you. Our preference is to hold our companies for the very long term – indeed for the first 10 years of the Buffettology Fund the portfolio turnover implied an average holding period of more than 12 years.’

There are two core reasons why Sanford DeLand sells a holding, namely ‘fundamental change’ and ‘oversight’. Burns regards fundamental change as ‘something that has changed for the worse and isn’t likely to get better anytime soon’. Examples might be ‘an adverse change in regulation, a new strategy and/or management team or, worst of all, a “transformational” acquisition.

‘Often the latter does more to transform the fortunes of the vendor or the advisers working on the deal than it does shareholder value.’ Oversight is a polite way of saying the managers got something wrong in their original investment thesis. ‘It happens,’ concedes Burns. ‘No investor is infallible but the important thing is to learn from those mistakes and not to repeat them.’

An art not a science

Richard de Lisle, manager of the VT De Lisle America Fund (B3QF3G6), says: ‘The most predictive factor of future performance is, inconveniently, momentum. Therefore, the best sell discipline may be not to have a sell discipline.

De Lisle continues: ‘This discussion is comparable to the age-old question about economics: “Is it a science or an art?” Peter Lynch, one of the best fund managers ever (he delivered a compounded annual return of 29.2% for Fidelity’s Magellan Fund in the 1980s), said that he got more from his study of philosophy than from anything else. He tended to sell when everything was going
very well.

‘We agree. For us, the investment case changes daily. Valuation is a moving target based on so many variables, both endogenous and exogenous to the company, that we have little hard targeting to use. Shares are therefore sold for a conjunction of reasons, none of which can be quantified except in the context of the time they apply. Quant methods are best used for buying. The variables for selling are so numerous, a sale can best be summarised as a feeling because selling is, after all, an art, not a science.’

Richard Scrope, manager of the VT Tyndall Global Select Fund (BGRCF38), points out there are many situations when investors might sell a stock, from a fundamental weakening of the financial position to a deterioration in a company’s competitive advantage. However, in addition to these considerations, his approach is to apply a three-point screen for all stocks in the portfolio which every position must pass.

‘A failure to satisfy any one of these three factors would result in the sale of the position,’ explains Scrope. ‘The three fundamental questions we ask are: Do you understand the company in its entirety? Is it economically profitable throughout the cycle? Do you trust the management?’

VT Tyndall Global Select doesn’t use price targets or stop losses as Scrope believes these are ‘destructive to investor capital. In our view, if the investment case remains, a significant price correction should be viewed as an opportunity to buy more, not crystalise a loss.

‘As long-term investors, avoiding the heuristic tendency to react to short-term news flow is paramount and rather than selling, we believe the first reaction should be to sit tight while continuing to challenge the investment case that led us to invest in a stock in the first place.’

Some less obvious considerations when selling shares for Dowgate Wealth’s Laurence Hulse, manager of smaller companies-focused investment trust Onward Opportunities (ONWD:AIM), include the retirement of industry heavyweights, as well as the examination of forecast margins versus through-the-cycle peaks and the direction of travel of metrics such as cash conversion, return on invested capital and cash flow return on capital. On a more light-hearted note, Hulse was once put off buying a share in a turnaround situation when the CEO revealed he had a golf handicap of two suggesting way too much time on the course.

Why governance matters

David Elton, manager of the CFP Castlefield Sustainable UK Smaller Companies Fund (B1XQNH9), monitors investments using not only traditional financial criteria, but also on a range of other factors because ‘we want to distinguish where non-financial risks (like ESG) might morph into business and financial risks which might ultimately impair the value of a clients’ investment.

‘For example, from time to time we’ve faced hold/sell decisions around the “G” of ESG – i.e., governance matters within a company. In one such situation, our investment case was impaired following what we saw as a lack of oversight and responsibility being taken amidst a challenging backdrop. This led to us losing confidence in management’s ability to turn that business around and we exited the holding, avoiding further share price volatility and downside.’

Elton explains that governance concerns also have ‘the potential to create negative headlines, such as when a company seems to be out of step with public sentiment. In rare cases, where the reputational risk surrounding a company becomes too high and is a significant distraction for management, we can no longer justify its position in portfolios and our process may lead us to sell the shares.

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