Every investor, however experienced, wants to get as close as possible to knowing when is the best time to buy and when to sell stocks and shares in stock markets.
The investor gets a buzz out of spotting a promising share and seeing it climb. He needs to decide when to take a profit, which is hard to get right.
Also, they have to recognise that some stocks in the portfolio are not going anywhere or worse, are dead ducks and should be sold, at a loss if necessary. Harder to do.
Listening to experienced investors helps. Through practise, they are better at making buy/sell rational decisions and they are better able to manage their trading biases.
The risk averse investor
The risk averse favour investing in a selection of big, well-established reliable companies known as blue chips (a poker term where the blue chips were of the highest value).
These are seen as quality, long term investments and on the London stock market include BP, Shell, Astra Zeneca, Unilever, Reckitt Benckiser, Rolls Royce, Vodafone, HSBC, GlaxoSmithKline, paying a regular dividend and also achieving capital growth.
Investment in quality stocks can have the advantage of not having to trade so often, as exemplified by many fund managers and Warren Buffet who keeps some of his holdings for decades.
However, even a blue chip can go off the rails. Things went disastrously wrong for BP when its Deepwater Horizon platform exploded in 2010. It cost BP $62bn. It cut its dividend, but it got back up and resumed its dividend.
Stock picking the quality
Anthony Bolton, legendary fund manager of Fidelity International’s Special Situations fund in the 1990s, commented that he lets his ideas accumulate in his mind until he has a conviction that something is the right thing to buy or sell.
He said in his book Investing with Anthony Bolton, “You need both knowledge of what constitutes a good company and an insight into how a company of its type should be valued. It is then a question of spotting anomalies, assimilating new information as it comes in, and waiting for conviction to develop.”
One key test in working out value versus price is to look at a share’s price-earnings (p/e) ratio. This measures the price of the shares (£10 each for example), divided by its earnings per share (£1.25p).
The result is a p/e ratio of 8, meaning it will take the company eight years to equal the share price in dividend payments. Superficially, this looks a reasonable p/e or ‘earnings multiple’ because it is in single figures.
A rough rule of thumb is that a company with a single digit p/e ratio looks promising. A high p/e in the late teens and more should flash warning lights: is the dividend about to be cut? A share with a high multiple looks over valued. However, sectors can have different earnings multiples, for example property companies have high p/e s.
Useful benchmarks from Bolton.
When assessing a company with a view to investment, it is good to have some sort of bench marks. Here are some pointers from Bolton:
- Understand the business, and its quality.
- Favour simple rather than over complex businesses.
- Seek a candid, balanced view from the business’s people.
- Study the balance sheet and the risk therein.
- Try to think two moves ahead of the crowd.
- Re-examine your investment thesis regularly.
- Forget about the price you paid for shares, sell them if circumstances change.
Everyone prefers buying to selling
Whether it is eBay or company shares, it is more fun to buy than to sell. Retail therapy makes people feel upbeat, empowered.
With shares, we are happy to buy but we don’t like to accept that some buys turn out a disappointment. People feel the pain of a loss twice as strongly they do from a gain and they like to avoid loss. Psychologists call this ‘loss aversion bias’.
Traders need to try to resist routine irrational biases such as loss aversion because they are bad news in money making.
Another bit of psychology that stops investors selling is the ‘endowment effect’. It is accepted that people rate something higher if they own it, so it is hard for investors to admit that the share they own with pride is not a success and they should sell it.
Having said that, some investors suffer from disposition effect when they sell too soon in an upward moving market in a bid to lock in a modest profit rather than wait for a better profit. They are also locked into the wish that failing stocks will bounce back, so they don’t sell and cut their losses.
Sell when you’ve checked and double checked
Selling is the hard bit for investors, whether to hang on or not. Experienced fund managers pride themselves on being able to say “sell” when a red light(s) come on.
News may suggest that a company has got itself into a mess, the CEO has resigned, or it emerges that the firm’s debt is much higher than what appeared in the annual report. If so, the time to sell has come.
One of the signals to sell is when the share price is in excess of what is thought to be the share’s overall value. The earnings multiple is vital here. If the stock’s multiple is higher than other stocks in the same sector, then the stock could be overvalued and its other fundamentals need examining.
There can be a fine line between the disposition affect (selling a share too soon) and deciding to sell a share because you think it is nearing the top of its rise. But how long is this piece of string?
Getting a stock sold at the right time is not easy and it has something to do with luck. For all anyone knows the market could unexpectedly fall back. As the adage goes, sell before the top and buy above the bottom.
Investors with strong track records like Warren Buffett, Anthony Bolton and Neil Woodford (flagship UK fund CF Woodford Equity Income), have shown how successful trading can be effected, again and again, for years.
Dip in and out – a bit
Investors sometimes forget that they can always enter the market later and buy the same share again. Investment writer and stock market trader Peter Shearlock is happy to sell at one price, waiting for the shares to drop and then buying in again.
Shearlock points to UK home furnishings retailer Dunelm Group whose share price has been on the defensive this year but it is on the up. There was good trading there.
He also says that the trials at Cobham, the UK tech and services innovator, where profits warnings and debt problems have been issues, has also provided a golden opportunity to make a turn.
Cobham's LED Drogue Illumination System for aerial refuelling. Source Cobham.
Like many other investors, Shearlock is a stock picker who goes for company value. He comments: “There has to be a solid business that has a defensible niche or some other 'market-related edge', a decent balance sheet and dividend-paying power that would survive a temporary hiccup.”
“Analysts think short-term. One or two missed profit forecasts are enough for them to go permanently cold on a share and the price sinks. For me, that is the moment when I start to look for long-term value.
“Always ask yourself, as a holder of a share, would I buy it at this price, or would anyone else? That may be your best guide on whether to hold on or not.”
Keeping investment fit
Buying and selling shares can be fun and profitable. But like exercising in the gym to build muscle, if you aren’t diligent the muscle/share awareness will fade away.
Whether buying or selling, you have to be up to speed on what is happening in the world’s economies, interest rates, trade, politics, the markets and their sectors, to be on top.
Too many investors buy shares they fancy and then forget about them for too long, while investment scenarios change. Next thing, that clever fintech firm has gone bust.
Don’t let shares languish. Sell and invest in something new and hopefully a better choice.
Many times it’s not obvious whether you should stay with, or sell, a share, that’s why so many traders on any stock exchange get it wrong. You need to do your own assessment, but also have a chat with a fellow investor. Having a second or third opinion can help clarify.
Anthony Bolton is a contrarian; someone who does not go with the crowd.
He said that when there is great optimism or pessimism [in the markets], he reminded his colleagues that the market is an excellent discounting mechanism.
He counselled: “By the time everyone is worried about something it is normally largely in the price.” That could be a good time buy. It is already too late to sell.