To Sell or Not to Sell: Perfecting the Strategy of Stock Exits

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Welcome to the Supernatural Stocks Podcast on Moneyweb, hosted by The Finance Ghost, your go-to source for local and international insights tailored for investors and traders.

Recently, I received a request via social media to address the challenging topic of when to sell a stock on Supernatural Stocks. This is perhaps one of the toughest hurdles in investing, and I am doing my best to tackle it. Thank you for your suggestions, and please keep them coming!

Option 1: This stock is for sale in two-thousand-and-never!

Once, it was believed that ‘Diamonds are forever’—a claim promoted by De Beers. However, the emergence of lab-created diamonds has changed that narrative.

This serves as a crucial lesson for anyone who thinks they can indefinitely hold onto a stock.

Even Warren Buffett sometimes sells shares, only to regret it later when he sees the price soar after his sale.

This brings us two key insights:

1. Being a long-term investor doesn’t mean you can never sell; and
2. You’ll drive yourself mad by analyzing every decision with hindsight.

That said, it’s important to learn from mistakes while understanding the difference between genuine errors and the unrealistic pursuit of perfect timing.

Here’s a personal lesson I learned the hard way: Transaction Capital.

This stock was my go-to choice among local options; my “forever” stock.

SA Taxi appeared to be a fantastic business. Hindsight may be 20/20, but if Sabvest faced troubles and Chris Seabrooke was nearly involved with Transaction Capital, how could retail investors like us comprehend the underlying issues?

Plus, Transaction Capital Risk Services (now Nutun) seemed robust, with WeBuyCars viewed as the growth engine I was quite confident in. Having worked with the Transaction Capital management team years ago, I believed I understood their capacity for effective capital allocation.

The stage was set for disappointment. Why? Because I was naive. I’m not just referring to the pandemic’s unforeseen impact on SA Taxi—the market randomness that can’t be anticipated; I’m talking about the valuation.

I should have sold when the share price shot up.

I should have definitely sold when the TCRS business leader sold shares. I remember thinking about it, but ultimately I decided to remain greedy.

What’s that saying about pigs? Right, bulls and bears make money, but pigs—pigs get slaughtered. I was the pig. I got slaughtered.

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While I faced difficulties due to what was ultimately revealed to be a severely flawed balance sheet, I must confess I had it coming. I had labeled a stock as “forever.”

Conditional love. That’s the kind of love you need for your stocks.

Reserve the unconditional, forever-love for your children, or perhaps your dog—or in my case, my cat. Always be alert when executives are selling shares that appear significantly overpriced. Such insights are crucial, regardless of your attachment to a stock.

Option 2: There’s a price, and I’m sticking to it

Welcome to the realm of trading. Here, you set a target price. You use technical indicators to pinpoint the right entry points, employing everything from momentum indicators to techniques that seem almost like reading tea leaves.

However you decide on your initial action, a clear strategy typically guides your exit. You’ll establish a price at which you previously committed to selling. In fact, you may have already programmed that order into your trading system.

This is trading, not investing. If held for longer, it might fall into swing trading territory, where positions receive more time to unfold. Regardless, the selling price is contingent on elements like key resistance levels or Fibonacci lines, rather than cash flow multiples at that moment.

Top traders excel in two primary areas:

1. Chart reading – interpreting market signals; and
2. Strict adherence to a plan.

Discussions with traders or tuning into trading podcasts reveal an interesting insight: most regrets arise from not following their trading strategies. In other words, it comes down to not selling at the target price they had set – often holding out for more instead.

It appears traders and investors have more in common than anticipated, right? Pigs get slaughtered in both instances.

Option 3: The best of both worlds

Declaring that you’ll hold onto a stock forever is indeed problematic. Stipulating a concrete price target for a short-term exit classifies you as a trader instead of an investor, pushing you to constantly seek new opportunities rather than allowing your money to grow over time.

So, is there a middle ground?

Absolutely. A wide spectrum lies in between; various styles and strategies exist. This intricacy makes the topic captivating. Thus, identifying the two extremes is vital as we comprehend differing approaches.

What follows is a framework I find beneficial and often employ myself. I’ve devised it, and I’m always receptive to feedback, especially constructive criticism!

Question 1: What is the chart indicating?

I intentionally start with the chart rather than external factors you should consider on your own. Why? Because the market comprises participants scrutinizing the same asset as you, making the chart invaluable. Why not incorporate their insights from the beginning? It’s comparable to conducting a poll in Who Wants to Be a Millionaire?—but you can do it continuously, not just once during a lifeline.

In simple terms, is the chart trending upwards towards the upper right corner, or does it show signs of stabilizing or declining?

Momentum serves as the strongest force in the market, able to drive prices to irrational heights, greatly benefiting those who retain their positions.

Traders ‘let their winners run,’ and with good reason. Still, they closely monitor when an exit signal starts to shine.

When a stock becomes over-extended, significant concern arises. However, if growth potential persists and strong momentum continues, now may not be the time to sell, or you might end up regretting it.

Begin with the chart and observe what market participants believe before conducting your analysis.

Question 2: What does common sense suggest?

You won’t find this on a chart. Ironically, common sense can be scarce. Individuals tend to cling to beliefs that reflect their current situations. When everything seems perfect, they’ll rush to discover more validation for those beliefs. This phenomenon exemplifies the confirmation bias we all experience.

Therefore, you can’t solely depend on charts. While momentum is captivating—it can fade rapidly, causing a stock’s price to drop significantly. In the time it takes to brew a cup of coffee, a stock’s price could drop 15%, generating frustrations unless you’ve established trailing stop losses that adjust with price increases.

So, why focus on common sense? Because a simpler-to-understand business is generally easier and arguably less risky to maintain.

Reflecting on the Transaction Capital situation—it was indeed a complex entity, fraught with numerous hidden risks, many of which I conveniently overlooked due to my enthusiasm for WeBuyCars. We know how that story ended. Thankfully, I now directly hold WeBuyCars, and that position has performed exceptionally well this year.

Am I risking a repeat of the same mistake with WeBuyCars? The difference lies in the fact that WeBuyCars operates as a straightforward business.

Several common-sense factors suggest they could continue thriving and capturing market share. There’s no need to sift through extensive notes on financial derivatives to appreciate their profit-making potential. A simple visit to WeBuyCars or selling them your car suffices. Unfortunately, I couldn’t experience SA Taxi as a consumer, nor could I comprehend all the intricate risks tied to that operation.

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I believe this makes it easier to continue holding WeBuyCars, though certainly not indefinitely—we’ve already established that blind affection belongs to your children, not your investments.

Question 3: What do the multiples indicate versus averages?

Finally, when a considerable trading history exists, assess current multiples against historical trading levels. Yes, a share price may have ballooned significantly, but if profits have kept pace and multiples align with historical averages, then who cares? It’s logical if price increases correlate with earnings growth.

There’s a vital distinction between a share trading at a price-to-earnings (PE) ratio of 15 times following a 50% increase or 25 times under the same conditions.

If the long-term average rests at, let’s say, 20 times, the former scenario indicates a stock priced below its average despite the rally, while the latter signals a stock that has exceeded its average and may risk a decline.

In both situations, the share price has appreciated 50%, making the percentage return equal. However, I would feel much more comfortable holding the first stock, hoping it returns to its average, while the second stock warrants trimming or complete selling in anticipation of a multiple contraction.

Closing thoughts: Churn and taxes

Exercise caution about over-analyzing when to sell.

Selling incurs taxes, which can significantly diminish your long-term earnings, especially as you may face income tax if selling within three years rather than capital gains tax. This means you’re compounding annually using post-tax returns, while those who continue to hold are compounding pre-tax figures.

This is partly why fund managers have a competitive edge in the market; fund structures often avoid taxation when adjusting positions.

Finally, be aware of the costs linked with frequent trading. It’s not just your brokerage fees; it’s also the time spent observing the market (which has its own cost) and the potential gains you might miss by selling prematurely.

Over the long haul, markets tend to rise. Isn’t that your reason for investing?

The most successful companies will consistently reach new heights. That’s our goal.

Be cautious when selling, but don’t completely rule it out, as I certainly learned the hard way.

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