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.