You invested in a company after researching well. After several months, the price is moving in the right direction but now you have another dilemma; do you hold the stock or take the profit? At times, it is even more difficult when there is a decline in the price. It could just be temporary but what does the price drop mean? The ability to determine when to hold or sell is a critical part of investing. This should not only depend on the fact that the price is rising or falling. Investors should consider the firm, valuation, investment thesis and changing markets. Here are some factors that can help you make a more informed decision.

Begin with why you originally purchased the stock

When determining whether you should hold onto the stock or sell it, start by revisiting the rationale behind the purchase in the first place. You may have purchased the stock for reasons such as:

• Anticipation of growth in the long term
• Strong fundamentals of the business
• Belief that the stock was under-valued
• Competitive advantage of the business
• Exposure to a certain industry
• Financial objective of yours

Now determine:

Is the rationale still valid? If the performance of the business is as expected and your original thesis holds true, it may not always be a good reason to sell the stock because of its price drop. However, if the rationale behind your purchase has changed, it could be worth reconsidering the position.

Don’t Sell Because of Stock’s Fall in Price

It feels awkward when a stock you bought at ₹500 falls to ₹420 and all you think of doing is getting rid of it before things go further south. But this doesn’t necessarily mean that it’s gotten worse as an investment.

Consider:

• Have the finances of the company gotten worse?
• Has the outlook of the business changed for the worse?
• Has there been any change in the level of debt of the company?
• Has there been any deterioration in the competitive advantage of the company?
• Was the original valuation premise faulty?
• Has the fall been mainly driven by the market?

But But Don’t Hold a Stock Forever Just Because You Believe in It

Another extreme is when people get too emotionally tied up with a stock that they just keep holding it regardless of what changes have occurred within the business. The key to holding a stock is not simply because: “I’ve already put money into this stock.” In case the business fundamentals have shifted or changed drastically and the investment thesis is no longer valid, you need another reason to keep your position. Do the following exercise: “Suppose that I did not own this stock. If I was considering purchasing it today, would I buy it at this price?” And if the answer is negative, find out why. This approach will help you avoid emotional attachment to your stock position.

Check the Company’s Financial Performance

Before making any decision about whether to hold a stock or sell it, analyze its financial performance recently. The criteria should include:

• Revenue growth
• Profit growth
• Margins
• Cash flow
• Debt
• ROE
• Earnings consistency

Just one poor quarterly result does not automatically imply problems within the business. However, a consistent decline in several quarters should be looked into more carefully.

Valuing the Stock

It is possible for a business to be fundamentally sound but have an expensive stock. Let us assume that you bought the stock when the stock was fairly valued. However, with time, the value of the stock increases considerably while the earnings do not grow as much. The business might be sound, but the stock can now be priced assuming very rapid growth.

Here, valuations come into play. Based on the kind of company and industry it operates in, some valuation ratios that investors might consider include:

• Price to Earnings Ratio (P/E)
• Price to Book Value Ratio (P/B)
• Enterprise Value to Earnings before Interest Taxes Depreciation Amortization (EV/EBITDA)
• Price to Sales ratio
• Dividend Yield

These figures are more valuable when analyzed against the historical valuation of the business in question and its peers, as opposed to being looked at on their own.

Think About Whether You’ve Reached Your Goal for the Business

Selling stocks is not always done because something is wrong. Often, selling has to do with reaching the initial goal or target. For instance, if your target was to reach a certain financial milestone through the investment, then reaching the goal would require you to rethink holding onto the shares. Nevertheless, you should not view a predetermined percentage as a sure sign of selling any stocks out there. Sometimes good businesses have a potential of making even more money after meeting the initial target.

Consider Your Time Horizon

Your time horizon might play a major role in determining your decision. A long-term investor will not mind the short-term volatility as long as the business is looking good for the long run. In the case of a short-term trader, he or she might have taken the position on a certain technical set-up. If that does not materialize, it will be wise to get out of the trade even though the business might look good fundamentally. Hence, do not judge the trade from a time horizon you did not initially use.

Let the Purchase Price Not Be the Sole Determining Factor in the Decision

In some cases, the investor would like to hold on to the investment because he does not want to take the loss. In other cases, the investor might sell too quickly simply because he wants to make money out of it. In both these cases, the purchase price has created an emotional attachment to the stock. The right thing to do is consider whether the prospects of the investment have improved or deteriorated. The stock has no idea how much you paid for it. The better question to ask is: “Based on my knowledge, is this a good investment at its current price?”

Consider If You Are Overexposed To One Stock

There could come a time where a stock is a sound buy but is not needed at the same exposure levels as before. This would be the case when a stock you first purchased made up 10% of your portfolio but after seeing a substantial rise in share price, it now makes up 25%. This is assuming that the company is still a solid stock but it could be said that your portfolio is overexposed. At this point, it might be necessary for you to rebalance.

Look Out For Developments That Will Have A Material Effect On Your Thesis

It’s not all bad news that should prompt you to take action. It’s important that you concentrate your attention on material developments that may have an impact on the future of the company. These can be:

• A significant drop in profitability
• Financial difficulties or increasing indebtedness
• Loss of competitive edge
• Any regulatory changes
• Management issues
• Any business segment lost
• Industry structure shifts

It’s really about whether this development changes the potential of the company for generating earnings.

Don’t Make the Call Based on Other People’s Targets

A stock may be recommended to be bought at ₹500 and its target could be ₹650. But just because a target is suggested, it does not mean that you need to base your decision on it. Your time horizons, risk appetite, portfolio diversification and expectation can all differ from those of the recommender. Similarly, don’t continue holding the stock just because someone expects it to recover eventually. Conduct your own due diligence and come up with a revised judgment.

A Checklist for Holding or Selling the Stock

When in doubt whether to sell or hold a stock, consider the following questions:

• Is my initial reason for buying the stock still valid?
• What is the current financial performance of the company?
• Is the current valuation justified?
• Anything fundamental has changed about the stock?
• Is this stock still aligned with my investment strategy and timeline?
• Is it getting too dominant in my portfolio?
• Would I buy it if I wasn’t already holding it now?

They will help in shifting the focus away from emotions and current price changes to what truly counts.

Both Holding and Selling Belong to Investing

No golden rule exists that requires you to buy and keep your stocks forever or to sell them once a certain level of profits is reached. It happens that at some moment it is best to hold stocks as the company is still good and not overvalued. It may be the case when selling is needed because the rationale behind the purchase is not valid anymore, the stock is overvalued, there is too much concentration in your portfolio or it simply does not meet your objectives anymore.

Consider the Business, Not Just the Price

The price of a stock is subject to fluctuations on a daily basis. However, your thesis for investing in a particular firm should not be subject to such fluctuations. When making decisions about retaining the stock or selling it off, go back to the core business and see how well it is doing in terms of financials, valuation, future projections and whether it fits within your investment goals. If your thesis is still valid, short term fluctuation could simply be an aspect of the process. If the reasons for holding on to the stock have changed, not selling just because you do not want to could be equally perilous.

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FAQs

1. Should I sell a stock when it falls?
Not necessarily. A price decline alone doesn’t determine whether a stock should be sold. Consider whether the company’s fundamentals, outlook and your original investment thesis have changed.

2. When should I consider selling a profitable stock?
You may consider selling when the valuation becomes excessive, your investment goal has been achieved, the business outlook has weakened or the position has become too large in your portfolio.

3. Should I sell a stock if its fundamentals deteriorate?
A significant deterioration in fundamentals can be a reason to reassess the investment. Whether to sell depends on the extent and likely persistence of the change.

4. Is it better to hold a stock for the long term?
Long-term holding can work well when the underlying business continues to have strong prospects and the valuation remains reasonable. Holding indefinitely isn’t automatically the right strategy.

5. How can I decide whether to hold or sell a stock?
Review the original investment thesis, financial performance, valuation, business outlook, portfolio allocation and your investment goals. Avoid making the decision solely based on recent price movements or emotions.