Everyone wants to believe that they are better at stock picking than everyone else – this includes expert stock analysts. There are some who are the real deal. For these same people, what you normally see are the results. But what we don’t often see is the underlying efforts in the process of doing so. Are you ‘lost’ so far?
Stock picking should be no different from buying a new house or new car. With so many parameters, both obvious and subtle in the stock market, this makes equities investment so much more intellectually stimulating or emotionally overwhelming.
We try to build a list of questions and guidelines to lead us through in the BUY/SELL decisions.
Your Guide to the BUY decision
You should be able to answer “Yes” confidently to ALL five pointers below before you make your BUY decision.
Am I Only Investing Money I Won’t Need for the Next 5–10 Years?
You should never invest money that you intend to use or unexpectedly need to tap on in the near future, which is typically for the next 5 – 10 years. When the market suffers a deep decline, while it will most certainly recover over the next 10 years, your investment monies may not be readily available for you to draw upon for urgent needs such as debts, mortgage payments, retirement expenses, medical bills etc. By doing so, your investment would not have been given the chance to sit out the market downs.
Is This the Best Possible Stock for My Investment Strategy?
Your conviction should be clear and compelling for any BUYs. Prior to a stock purchase, you would have done solid research by studying all parameters of the underlying company relating to your investment strategy. For example:
- Is it a leader market leader?
- Is the company competing in a fast-growth industry?
- Is it massively undervalued against its industry peers?
- Does it offer a sustainable and strong dividend?
- Has it delivered ten years of steady above-average sales and profit growth?
Do I Have a Good Way to Follow This Stock in the Future?
Your homework doesn’t end at the click of the BUY button. Much like your insurance policies, there is a need to continuously follow up and review. Make sure you have some way to follow important new developments.
One habit is to set aside some time each week to read up on new developments around your investment portfolio. Materials could include updates from financial data providers, investment newsletters or even from your financial advisers.
For example, if you are a dividend investor whose main aim is to collect steady dividend income. How will you know if the company has boost, cut, or fail to raise the dividend?
Do I Have a Way to Tell If My Thesis (conviction) Is Playing Out Correctly?
This is where you question whether your investment thesis or initial conviction in the stock is panning out correctly after some time. You look out for future metrics, developments, indicators or signs.
For example, if you had bought SingTel ten years ago for its steady dividend, you will want to periodically check out SingTel’s dividend yield and growth, payout ratio, long-term debt etc. If at some point you see some of these metrics deteriorating, it may suggest that SingTel is no longer the steady dividend stock you had originally bought and held on to. It is time to sell.
However if all metrics continue to look good, hold on to your stock as you know your thesis is working.
Have I checked that this stock fits with my overall portfolio?
You need to ensure that the new stock fits well with your overall portfolio and its objectives. This includes ensuring that your portfolio is not overly concentrated in some areas.
For example, is this the 9th banking stock you are adding to your portfolio? Is it too much of a focus on the finance sector? Or, are you putting 40% into a single position while your other 60% is spread among 12 other stocks?
Your Guide to the SELL decision
Unlike the BUY guide, any time you say “Yes” to ANY of the questions below is a good enough reason to make a SELL decision and move on to something better.
Does the Stock No Longer Fit My Investment Strategy or Goals?
If the original intent of a stock was for a particular objective and is now no longer fitting your strategy, it is time to let it go.
For example, if the REIT (Real Estate Investment Trust) that you had bought was for steady dividend income, and the company cuts its dividend payments due to consistent poor results, the stock has gone astray and is no longer serving your goals.
Is There a Clearly Better Alternative to Serve My Investment Goals?
I have mentioned before. As a pure investor, I am “not bounded” to any of the stock counters that I am vested in nor intending to invest in. I don’t buy stock because I like the brand, the products or services, the industry etc. No sentiments, no brand loyalty, no hard feelings. Investors should discard these unnecessary attachments but constantly look out for better stocks to achieve their goals.
If you want consistent dividend income streams, then you should constantly be looking out for consistent dividend players with better dividends than those you currently own. The market constantly brings up opportunities as stocks go through a cycle of being undervalued or overvalued, improving or declining company performance etc.
Does My Original Investment Thesis (conviction) Now Appear Wrong?
There is no need to stick with a strategy once it heads wrong with new information. This brings up the need to periodically review new information and adapt investments accordingly.
For example, you predict a recession and move your monies into lower risk instruments such as bonds. If it becomes clear that it is a temporary decline, it is logical to reallocate the monies to more optimum use.
Does Financial Performance Seem to Be Falling Apart?
If a company consistently reports mediocre earnings, it may indicate that the business is struggling or financial performance coming apart. This is a clear sign to sell.
Does Management Appear Incapable or Incompetent?
The executive leadership shapes and executes major strategic and operational decisions, thus their resulting actions and behaviour can have high impact on a stock. If the company executives seem incompetent for the job or otherwise unsuited to lead the company, it it time to hunt for better altervatives.
Does the Stock Seem Extremely Overvalued?
There is a difference between overvalued and extremely overvalued. It is common for stocks to be trading slightly above its fair value. However, when a stock becomes extremely overvalued, it has nowhere to go but down.
When the stock starts to trade at 20%-50% above what you assess is a fair price, it might be opportune to lock in your profits and wait for it to retrace, or consider buying alternate shares.
Are There Signs of Serious Financial Fraud/ Corruption/ Criminal Activity?
This is foolproof. Sell on signs of serious fraud, corruption or criminal activity. Companies that have been breaking the law tend to experience long periods of struggle. Investigations often take time and usually dig out more wrongdoing beneath the surface. Why choose to own a rotten apple among all the stocks in the market?
Has the Stock Grown to Make Up Too Much of My Portfolio Weight?
Nothing to do with the company but more on portfolio re-balancing for the investor. Owning 20 positions doesn’t equate proper diversity if the portfolio is overly concentrated in just a few counters.
You do need to constantly re-balance as some fluctuation is normal. But do start to take note when a single position starts to take up a significantly heavier weight as compared to the other stocks in your holdings.
Do I Have an Unexpected Financial Need for the Money?
Sometimes, you just need to drawn down your investment for unexpected expenses or new opportunities. While you do not have a choice, it is perfectly fine to sell off some of your stocks. Your portfolio continues to stay diversified if you trim off the sizes of individual positions rather than divest off a few stock counters totally.
Do I Want to Take a Capital Loss to Offset a Capital Gain?
This may not be applicable for individual investors in the local context.
Many investors review their portfolio at the year-end to do “tax loss harvesting”. When an investor realize a loss on investment, he is allowed to place that loss against capital gains and avoid paying taxes on the amount. This keep investment profits in the portfolio.
Conclusion
The above isn’t a fully exhaustive list of reasons to make a BUY or SELL decision. However, it does covers some of the most common and important scenarios. If you were indecisive before, I hope this makes a better case next time for you when you make your investment decisions.
How do you fare so far?
Theory of Constraints 