I find that it is much easier for investors to buy stocks then it is for them to sell. I say this because I have seen investors who hold onto their investments all the way to bankruptcy, or when the stock has made a sizeable gain and the investor still refuses to sell. Some of the thought process that goes on are:
- They believe the stock still has more room to go up in price so they patiently wait for it to increase further, only to miss out when it was at its peak.
The stock has dropped and the investor believed it had bottomed out and it will go up again, so they continue to hold
The stock has dropped so much that by this point, selling it would cause a big loss, so they hold onto it in the hopes that one day it could go back up again
Sad to say, I was a victim of those type of thinking too. To get out of this type of thinking, people should be mindful of the following and pay attention to the signs of when to sell your stocks.
PE Ratio is Too High
The PE Ratio or the Price/ Earnings ratio calculates what optimal price an investor should pay based on what the company’s annual earnings are and the market price of the company. The formula for the PE ratio is calculated as:
Market Price per Share/ Earnings per Share (EPS)
If a company has a PE ratio of 16x, that means that for each dollar in annual earnings the company makes, the investor will need to spend $16 to attain a Earnings Per Share of $1.
Knowing how the PE ratio works is only part of the puzzle. The PE ratio needs to be compared to the competitors and the industry. If the PE ratio in your equity holding is higher than its competitors then likely your company is overvalued and it may be time to sell. A good way to find out what your company’s PE ratio is by searching on Google Finance and typing your company’s name in the Google Search.
A lot of Negative News Coming From the Company
If there are a string of negative news coming out about the stock, do an assessment of whether it may be time to head for the exit doors. Keep in mind though that by the time you read all these negative news, it could already be too late. The stock market tends to react rather quickly when there is a whiff of negativity about any company traded on the stock exchange. A couple of negative news you should be on the look out for are the following:
Are the senior executives leaving? Could mean a restructuring is occurring
The CEO or CFO abruptly resigns without prior notice and no successor planned
Research/ Construction is behind schedule or there are cost overruns. (The Boeing 787 Dreamliner has been consistently plagued by problems and was behind schedule)
The political climate of where the company operates in has changed. (Ford took a hit in its recent financials because of the political climate in Russia)
There could be a number of factors that can cause a company to drop in value. But when these type of news do occur, look at the cash flow to see whether there are still business coming in and whether there is positive cash flow coming into the company.
The Growth Phase of The Company is Coming to An End
During the life cycle of a company, companies can enter the growth phase where the company is in hyper growth mode and is expanding and growing like crazy. There are new markets to enter and customers are clamouring for what the company has to offer. Think of Apple when they first released the iPhone or Groupon when they initially came out.
Generally, companies are able to sustain its growth much longer when there are high barriers to entry preventing new competition. For example: Groupon recently has been struggling because consumers are starting to get used the Groupon deals being offered and it is relatively inexpensive for startups to launch their own group buying websites.
Another area to keep an eye out for a long sustained growth phase is check to see whether the stock you own has a natural monopoly. For example: if the stock you own is a mining company, does the company have exclusive rights to mine the area?
There are a lot of things to pay attention to when you are debating on whether to sell your stocks or not. It is important to periodically look at your investments and determine whether it is time to sell some of those stocks.