I have been receiving this question and its variants via comments and emails for the last few days.

Let me try to answer this question from my point of view. My response may not be typical of what is usually recommended and may not suit your specific case.

I am wary of a simplistic approach of selling stocks at an X % profit or at predefined index or price level. A decision to sell, like buying is more nuanced and requires more thought than that.

Two criterias for selling
In my case, the selling criteria is part and parcel of the analysis done before buying the stock. I typically will have an exit criteria in mind based on fundamentals and valuation at the time of buying the stock. If the business fundamentals deteriorate more than expected (see my post on India nippon), then I will sell the stock if I think that the drop is not temporary and the intrinsic value will stagnate or drop in the future.

The second case where i sell the stock is when the current price exceeds the intrinsic value by 10-15% and the future increases in the intrinsic value is less than the returns I can get via other opportunities. So if the stock is selling at intrinsic value and I can find another idea at a 40% or higher discount, then I will sell the stock and re-invest the proceeds in the new idea.

You will notice a lack of reference to any pre-determined index levels or fixed increase in stock price in my sell criteria. For starters, index levels do not have a direct bearing on individual stock. My pick can stagnate when the index is rising and vice versa. So selling a stock just because the index has gone up would be foolish

Mental accounting
I will also not sell stock just because it has gone up by X% to ‘book’ some profit and leave my profits behind. This would be a clear case of mental accounting (put cost and profit in different mental accounts) and an attempt to avoid regret. If one breaks the investment into different mental accounts, there is tendency to recover the cost and let the profit run. I see no reason to treat profits any different from the cost. The entire money is just one single account (available capital) and it is important to take decision on the entire holding as such.

Avoiding regret
A common reason for selling is also to avoid regret. If the market drops, I will regret losing the profit. However I would say that in the short term, it is impossible to avoid regret. If the market rises, then you will end up regretting selling the stock and losing on the upside.

If I cannot predict the markets and avoid regret, the best option is to have an approach based on intrinsic value and accept the fact that I could face regret in the short term irrespective of my decision. The same scenario occurred for anyone who waited for the election results to commence buying. In order to avoid the regret of buying at a higher price and then see the price drop after the elections, they ended up watching the price shoot up and are now regretting missing the rise.

Final bias – hindsight bias
The silliest reason by far is to evaluate a decision based on how the market moves in the short term. If the market rises after I decide to hold the stock, does it make me smart or stupid if the market drops? absolutely not !!

All investing decisions have to be taken based on current information and in absence of knowing which way the market will move, my decision can appear to be very smart or stupid in the short run. However if you follow a rational approach of buying and selling stocks based on some measure of value, then short term market movements should not trouble you too much (which ofcourse is easier said than done)

I mentioned in my previous post, that I plan to use the current market rally to clean up my portfolio of some clunkers. In this post, i will also analyse why I plan to exit these stocks and what I have learnt from them (something good should come out of it 🙂 )

VST industries
I wrote about VST industries in 2007 and built up a small position over the course of a year. My key assumptions were

– The company had grown its net profit at around 20% in the past and would continue to grow it by 6-7% in the future.
– The company will continue to maintain its return on capital at current levels and a reasonable dividend payout (then Rs 20/ share)
– The catalyst for unlocking value could be higher dividend, better growth rates in the topline or continued good performance of the topline and bottom line.

So what has happened since then ?
– The growth has decelerated considerably. Initially the topline slowed down and in the current year the bottom line has been stagnant due to higher tobacco prices
– The company has increased its dividend to around 30 Rs/share and is thus returning majority of its free cash flow to the shareholder. This is good sign as the management is returning capital as it cannot re-invest it in the business and is also not blowing it away on needless diversification
– The catalyst for unlocking value was higher dividend (which has happened) and a reasonable growth rate (which has not happened).

The key reason for the price stagnation has been a slowdown in the growth rates, due to which the market continues to give (rightly so) a low PE to the stock. My mistake in the above idea was a failure to recognise that cigarettes are a low growth category and a no.3 player in this industry is not going to perform too well. The company has been doing fine and will plod along.

Although, One can look at the stock with a 10% dividend yield, there are risks to the business model and future profitability (government taxation and attitude towards smoking).

One final point – Although I have eked out a small gain, I got thrashed (figuratively speaking 🙂 ) by my wife for investing in a tobbaco stock. According to her, I deserve to lose money on such a stock :).

India nippon electricals
I analysed this stock for the first time in 2007. This was a graham style deep discount idea.

My key assumptions were

– The net profit had grown by around 4% in the last few years. I expected the company to maintain the past growth rates.
– The company had a cash holding of 77 crs then, which has now increased to almost 100crs+. The company has a market cap which is less than the cash on books.

So what has happened since then?

– The core business of the company is on a downward slide now. The topline and bottom lines are both decreasing.
– The cash holding has increased since then, however the management is just sitting on the cash without any specific plans for the same.
– The market consider this company worth more dead than alive due to the fact that the core business is sliding and the management has not been able to turn it around and at the same time not returned the surplus cash to the shareholders

My key mistake in the above case was to ignore the management quality. I expected the business to have a very average performance due to the nature of the auto components business. However I ignored the management’s lack of interest in taking any value enhancing actions via dividends or buybacks. They have been sitting on the cash for quite some time and have not bothered to raise the dividend till date.

Holding the stocks at the current price is better than holding cash in my case. However I plan to exit once I can find an attractive idea. These stocks represent around 2% of my total portfolio and hence the impact on the overall portfolio is minimal. However keeping them around would be a waste of capital.

I may or may not declare the exact time of the sale too. If however I decide to provide an update, it would be via twitter as such an update is not suited for a post. If you are interested in it, then you can follow me on twitter.

As always, please read the disclaimer !

I typically do a detailed analysis of any company before committing a decent amount of money to the idea.

I have uploaded a detailed analysis of BEL (bharat electronics) and balmer lawrie in the past. I use this spreadsheet as a checklist and template for a detailed analysis. The spreadsheet is simple (though time consuming) and can be done by anyone. The spreadsheet ensures that I think through the idea in detail, but does not prevent me from making stupid decisions everytime.

It however takes a couple of days of complete this spreadsheet and in the end I post the summary of the analysis via a post on the idea. I have posted an analysis of LMW (lakshmi machine works) in the past and you can download the spreadsheet analysis from here. This spreadsheet was generated at the time i published the post on the company. Suggestion – do look at the sensitivity tab in the spreadsheet.

I have been toying with idea of how I can publish these spreadsheets on an ongoing basis. I have done them for free till date and am not interested in charging or making money off them. I actually find the idea of selling stock tips quite repelling.

At the same time I plan to leverage my work for other means such as charity. I am still working on that idea and will post in detail when I have done the necessary groundwork on it.

My plan is to connect with a well know charity and use my website and stock ideas to encourage contributions. If my blog and the stock ideas have been useful to readers, I hope they will contribute to a good cause in exchange. This will ofcourse be ‘voluntary’ and I have no plans of commercializing this blog, which is clearly a personal passion for me.

please feel free to leave a comment or email me on my plan.

The last one week has seen one of the biggest spikes in stock prices. Almost every kind of stock, has recorded a big jump in prices. Those of us who were lucky or had the foresight or both in buying stocks in the last 6 months, are now sitting on decent gains and must be feeling pretty smart and good about themselves.

I would hold my horses on that.

There is no harm in feeling good about it, but I would not let this feeling stop me from thinking rationally on what to do next.

Planning based on market forecasts !
One cannot be sure whether these price levels will sustain themselves or not. You will find every tom dick and harry trying to forecast or predict on what is going to happen. Well, if you are basing your strategy on these kind of predictions, then good luck with that.

I, for one have no clue and will not plan based on anyone’s predicitions or my ‘feel’ of what is going to happen. I did not have a clue in march, that the market would go up so soon and I don’t have a clue about the future market direction now.

During the period october 08 to March 09, I was a net buyer and commited a decent amount of money on a simple logic – The prices of the stocks I liked were attractive and way below intrinsic value and when they dropped below 50% of the intrinsic value, I bought.

Plan going forward
I have been analysing the annual results of all the companies I hold and re-evaluating the intrinsic value. If the price after the runup is still below instrinsic value and I expect the company to continue to do well and accordingly increase the intrinsic value at a decent rate, I will continue to hold. It would be stupid of me to sell a stock which still sells below instrinsic value, just because it has gone up by x%.

So what to sell ?
Now may also be a good time do some portfolio clean up. There are some holdings, especially in my graham style portfolio which are not doing too well in terms of business performance.

These companies have a stagnant or decreasing intrinsic value and hence holding them longer is of no benefit. I plan to take advantage of the recent runup to sell such holding and re-invest the cash elsewhere.

Finally, if the stock price has exceeded the instrinsic value and I don’t expect the increase in intrinsic value to be above a certain threshold, I will start liquidating the holding.

Let me explain: Suppose my estimate of intrinsic value is 100 and stock sells at 120. Now lets assume for simplicity sake that I think the company will increase the instrinsic value at 10% per year. So by the end of year two, the intrinsic value of the stock would be 121. Now for sake of an argument, lets say that the stock will contine to sell at a 20% premium to instrinsic value – 141.

On the other hand I can liquidate the stock at 120 and invest the capital in another company which is selling at say, 40% discount to intrinsic value. If this company also increases its intrinsic value by 10% per year and at the end of year two sells at intrinsic value, then the value of my holding would be 242.

The above is ofcourse a simplistic sceanrio and there are several other factors involved, but the thought process should be clear.

It is important to try to remain rational at all times as far as possible. Being overly giddy and happy now will hurt as much as being fearful did in the last six months.