Long-term investors such as Warren Buffett defer from selling their shares. This is because they look to buying, holding and collecting returns from their investments. However, that does not mean that all stocks must be kept forever.
At times, companies that, although have delivered years of robust returns, begin to lose their sheen. On other occasions, a well-known stock could slip and become insignificant. And then there are those that you discover is a dud instead of a jewel.
However, it is critical to know when to sell stock in the Indian stock market as selling for the wrong reasons could be a costly error. Buying shares is much easier than knowing when to sell one. This is because, many investors are reactive and sell during a herd mentality phase – when negative emotions such as fear and panic take hold of the share market during a downturn.
Here are some signs to look into and decide when to sell stocks while keeping emotions out of sight.
#1 Warning sign: Extremely high P/E ratio
In spite of enjoying profitable returns from a stock that you have persevered for years, you must keep an eye on its Price to Earnings Ratio (P/E). This ratio fundamentally equates the company’s most recent earnings to the price of its shares. Just as a meagre P/E ratio can be a warning sign that the stock is tumbling, an equally high P/E ratio is an indication that the shares are overpriced and could plunge any moment.
Example: Microsoft stock skyrocketed over 15,600% from 1990 to 1999. Its P/E ratio revealed that the stock had gone well over into overpriced territory, trading at a value over 84 times than what it was gaining per share. When investors realised the stock was overpriced, most of them sold their shares, resulting in a loss of nearly 2/3 of Microsoft’s value in the year 2000.
Investigate thoroughly if a specific stock has a significantly high P/E ratio than its industry peers. Compare the P/E of the business with other companies in the same sector using analytical and financial information from a well-reputed stock broking company such as Kotak Securities.
#2 Warning sign: Poor competitive advantage
A company’s strength lies in its competitive advantage. Whether it is a premium product, brand, better pricing, services, etc., a business’ competitive advantage is the bulwark that keeps contenders from taking away its market share and profitability.
Example: Blockbuster was a behemoth in the rental movies space. Till the time Netflix entered the arena. With mail-order services, online streaming offers and more, Blockbuster eventually lost its competitive advantage and finally filed for bankruptcy in 2010
Look for broad changes in industry trends and analyse the latest headlines regarding your stock. Is there a new competitor offering an affordable price or better service? Is the company adapting to changes in consumer tastes faster than its contenders?
#3 Warning sign: Sudden change in upper management
You may have purchased a specific stock due to its robust management and sound business model. However, overnight, the company has replaced its leaders or altered its business model and vision. These drastic changes could significantly alter the company’s future profitability.
Although change is inevitable in any business if it loses its winning business model or the people that made it profitable, its time to consider. Study the profiles of the new management and changes in the model to understand if you want to hold onto the company’s future.
#4 Warning sign: Consistently poor sales
It can be challenging for companies to maintain a winning streak in a tough economy. But, if you notice a trend of declining revenue due to lack of sales, no new sources of income or trouble in marketing its products and services, it may be time to take a call.
Look into the annual income statement of the company to determine a steady top line and consistent growth over the years. If you notice a downward trend in revenues, particularly in a sector where its peers are experiencing enhanced growth in the same period, you may want to consider selling the stock.
Takeaway
To know when to sell a stock can be challenging even for expert investors, and hence, it can help to look into more than two or three warning signs before deciding to sell. Additional factors such as shrinking profit margins and slashed dividend payments to its shareholders are vital elements, in addition to the factors mentioned above.