Investing involves
- Buying,
- Holding and
- Selling.
Buying and holding an investment is most often covered and taught, but selling is least talked about. Hence, many new investors often find themselves hoarding investments and unwilling to let go even when circumstances change.
Today, let’s break down the art of selling a stock that you own.
Oftentimes, the number one barrier to sell is that the stock is still losing money, and there is an emotional attachment to money.
Investors never like to take a loss and this can prove costly.
Here’s why:
1 – Pricing anchoring and falling in love with your stock can be bad for your portfolio and wealth.
Remember that it is your money, the stock doesn’t care about how you feel.
Many investors have bought this stock at around $3 or $4 and are hoping that the stock would recover “one day” to their breakeven cost price before they sell. As of today’s writing, SPH is below $2 and most investors would be sitting at 30-50% losses.
Another example is Fastly (FSLY).
Many investors are holding on to this stock at an average cost of $80-90 or higher and hoping that the stock would one day recover.
They would be sitting at >30% losses.
2 – Sell when the story changes, when fundamentals of the business change, when you found a better company or when you made a mistake.
The opportunity cost of holding on and waiting for the price to recover can be big.
Investors often do not realise that the fundamentals of the business drive long term stock returns. When the fundamental of the business deteriorates, the fall in stock prices follow.
Here’s data that shows why SPH stock has been dropping since 2013:
Total revenues, operating profits and dividends have been declining!
The investor who had noticed the changes in SPH’s business fundamentals would have sold out early and allocated his capital to other stocks that could potentially give him a better future returns.
The losses would have been manageable even when the investor was to sell out in 2014 to 2016 at $3-$4 price range.
Likewise for Fastly.
I was invested in Fastly at an average price of $80. The highest price I bought was $101 in Aug 2020 and the lowest price I had averaged down to was $70 after their Q3 2020 earnings result in Oct 2020.
Fastly’s management has mentioned that their Content Delivery Network (CDN) with edge computing is faster and better. The important metric to take note of is that more than 80% of their revenues come from big enterprise customers who contribute >$100k of revenues per year.
For them to do well, I would expect customers to be signing up with them at an increasing rate. However, this is not the case looking at enterprise customer growth from Q2 to Q4 2020.
Fastly’s enterprise customer growth did not accelerate but instead, Cloudflare which is one of their competitors managed to onboard a lot more enterprise customers. In Q1 2020, both companies were temporarily affected by COVID-19.
When Fastly released their earnings in Q4 2020, I sold out everything as fast as I can at $87 market price and switched to other stocks. Luckily after checking my records, I still made a tiny profit.
I would have sold it regardless of whether I made a profit or a huge loss. I was determined to get rid of it because their numbers suggested issues with their sales execution. If their technology and sales execution is superior, more customers would likely sign up with them.
Fastly’s business performance was poor in contrast with Cloudflare which is signing up more and more enterprise customers. With the sale of Fastly stock, I bought more Cloudflare at $60+ and added other stocks.
If you’d like to invest in similar businesses, I share how I find and pick good ones here.
3 – It is rare to find a stock that you can hold forever
Most investors are collectors of stocks and their “ideal” period is to hold forever and never sell.
This is popularised by Warren Buffett when he said “Our favourite holding period is forever”. But if we were to analyse Buffett’s history of actions and words deeper, “holding forever” is only reserved for exceptionally great companies.
Such companies continue to have a huge competitive advantage, will continue to grow and continue to add tremendous value to shareholders.
Businesses have life cycles and holding forever is an ideal, not the reality.
In reality, it is rare to hold onto a stock forever because as businesses mature, they become too big to grow, inefficiencies creep in, management becomes complacent, new competitors start to disrupt their business and their fundamentals start to weaken.
Although all businesses would like to grow forever but in reality, this is not the case.
They tend to go through a Start-Up stage, Growth stage, Mature stage and then a stage of Decline:
Businesses that are resilient in the Mature Stages will fight all they can to avoid landing in Stage 6.
They reinvent their product and services with more R&D, they explore new markets, they continue to innovate and they try to avoid being disrupted. These are usually the best businesses to hold for the long term.
But these are rare.
4 – We all make mistakes.
Nobody is perfect. We all make mistakes. As an investor, you try to make the best decisions you can based on the current information you have.
Investing is extremely rewarding and requires some work. Many investors are often paralysed with too much information overload and usually you only need 1 to 2 key information to make the decision. Investing is also not difficult if you know how to.
However, we all make mistakes.
And the next best decision is to minimise those mistakes by getting rid of underperforming companies.
This brings us to the next point (which is oftentimes the most painful).
5 – Sell the loser
And buy the winner that can potentially give you better returns on your money.
Using my personal investing experience, selling off Fastly after their Q4 2020 earnings result on 17 Feb 2021 allowed me to avoid a 30% loss. Buying a better business, in this case, Cloudflare on 18 Feb 2021 has yielded a 30% profit.
This is the real opportunity cost of holding on to underperforming businesses and hoping that the stock price would recover.
Fastly’s stock price may recover back to $80-$90 range, however it might take 2 or 3 years. That is also an opportunity cost to consider.
6 – It is completely OK to buy again, even at a higher price.
If the company you sold does well again, it is completely OK to change your mind and buy it back again, even at a higher price.
If Fastly’s business turns around and they increase their enterprise customer acquisition, it is not too late to buy it back at a reasonable valuation.
Even if the price is higher than before. Refer to point 1 again, do not price anchor.
And those are the 6 scenarios where you should consider selling your stocks. If you’re wondering what to buy, join me at my free webinar to learn how I find and invest in hypergrowth stocks (my students and I are +70% YTD).
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Disclaimer: I’m vested in Cloudflare (NET)