- Investment strategies
- Why invest in the stock market?
- Buy and hold or technical analysis? Why you need an investment plan
- Value investing and short selling in volatile markets
- Using technical analysis to support value investing
- Investing in the unexpected
- Franking credits, explained
- What is dividend stripping and is it a sensible strategy?
- Investing in quality IPOs
- How to invest in stocks that benefit from a moving Australian dollar
- Reasons to avoid bonds when interest rates are low
- How value investors use Skaffold
- Quality, growth and value = a winning strategy
- Know your investor type and boost your performance
- Technical + fundamental analysis = better buy and sell decisions
- Fundamental investing
- Value investing and the price earnings ratio
- Intrinsic valuation models and methodology
- Value investments or value traps?
- How to find value stocks in a bull market
- Find value investments in expanding markets
- Why capital raisings struggle to add investment value
- How to value an insurance company
- Top stocks
- 5 qualities of top stocks
- How to find stocks with a competitive advantage
- Why return on equity is the best measure of business performance
- Using cash flow to find value investments
- Finding high quality dividend stocks
- Debt is not always a dirty word
- Why Skaffold share investment software makes sense
- Using economic factors to uncover the best investment options
- How do experts find top stocks to invest in?
- Investing in global stocks
- How to invest in international shares on global stock markets
- Benefits of investing in international shares
When is the best time to sell shares?
Most investors are less confident about locking in their profit by selling.
As a value investor you intuitively understand the importance of buying quality stocks with a good underlying business model when they’re trading at a discount to their intrinsic value. Everything being equal, the greater the discount between price and value, the more compelling the reason to buy.
The opposite is equally true. When the discount between price and value disappears, you may need to sell. Most investors are less confident about locking in their profit by selling.
Reasons to consider selling
Rather than agonising over selling early (as opposed to the very top), as a value investor your main goal is to maintain a portfolio of underpriced (quality) stocks most likely to outperform at minimal risk.
It’s true; the art of selling shares is considerably less predictable than buying. However, by identifying key trigger-points to prompt a timely portfolio review, we have provided you with some guiding principles for selling down a stock.
Let’s take a look at the key reasons why you might consider selling a stock down within your portfolio.
Price eclipses value
One of the cornerstones of value investing, championed by leading investor Warren Buffett, is the knowledge that a company’s share price cannot run ahead of its underlying performance forever. In other words, the share price and the company’s intrinsic value are destined to eventually converge.
The closer a company’s share price gets to its intrinsic value, the greater the risk of holding the stock. And the more the share price exceeds a company’s intrinsic value, the greater the argument for selling down. Whether you exit completely depends on your outlook for the stock, and any future upside to current valuations.
Here are some examples of share prices rising well above value and warranting a sell down.
Ten Network (TEN)
Since 2005 the underlying value of Ten Network (TEN) has declined, along with the price. And while the price tracked the underlying value, it has always been higher.
Webjet (WEB) is another example of a company where the share price rose well above value. In fact it was also higher than 2015 forecast estimates. WEB hit a high of more than $5.20 in April 2013. Its share price retreated to $3.90 in early June 2013 and has since risen back to around $4.50.
Skaffold Line chart plots WEB’s intrinsic value and share price
So when the share price runs ahead of value, don’t be too greedy and don’t rely on hope.
Cut and run
The same can be said when the share price and value are seriously uncorrelated. Setting aside chronic poor performers, it’s not always immediately clear why you should sell a stock, especially if it’s a former share market darling or has attracted investors due to its sheer size, so here are some important tips.
Remember, stocks that find themselves significantly underpriced have typically become that way for good reason: bad management, business performance, loss of their competitive edge. These factors result in declining intrinsic valuations and future growth that is less promising. In the long run, return on equity and (ROE) falls, along with cash flow.
Examples of quality companies that have suffered from deteriorating business performance and/or value include Leighton Holdings (LEI), Boral (BLD) and QBE Insurance.
In the case of Boral, the company’s return on equity (a strong measure of profitability), has gone from just under 20 per cent in 2004 to 3 per cent for the 2012/2013 financial year. Despite declining earnings, the company continued to pay a dividend. In 2010 BLD reported negative NPAT of $18.7 million, yet paid out dividends of $42 million. By 2012 the company was in a Funding Gap of almost $900 million. Unsurprisingly, since 2006 BLD’s share price has more than halved.
Leighton Holdings (LEI)
The recent history of one of Australia’s largest internationally operating businesses, Leighton Holdings, paints a similar picture. Between 2004 and 2009 LEI’s ROE rose from 17 per cent to almost 40 per cent , triggering a corresponding hike in the share price from below $10 to over $60.
But by 2011 LEI’s ROE dropped (well below the preferred 25 per cent) to 9.21 per cent, and the share price fell to around $17. Based on its December 2012 full year results, LEI was rated B2 by Skaffold. Its shares were trading at around a 20 per cent discount to the current intrinsic value estimate of around $21, which was forecast to rise to more than $22.50 by 2015.
Skaffold Line chart plots LEI’s intrinsic value and share price
QBE Insurance (QBE)
QBE is another example of the oft-quoted truism, ‘price eventually follows value’. In 2007 QBE reported EPS of $2.26. In 2012, QBE reported EPS of $0.73. Over that same period NPAT declined by more than $100 million, while debt increased to over 25 per cent of the company’s total equity.
From a peak of more than $31.78 in 2007, Skaffold estimates QBE’s underlying value has fallen by around 60 per cent, to $6.23 (as at 30/12/2012). Like LEI, Skaffold forecast QBE’s intrinsic value will rise over the next two years.
Skaffold Line chart plots QBE’s intrinsic value and share price
Oroton Group (ORL)
Then there are stocks like Oroton Group (ORL) and David Jones (DJL) where the future growth, due to a myriad of factors, no longer looks promising.
Skaffold Line chart plots ORL’s intrinsic value and share price
As you can see from the above examples, the trick is to take these smouldering time-bombs out of your portfolio before they do greater damage, and use the funds to buy superior investment opportunities elsewhere.