Broadly, there are 3 reasons to buy — Business, Management and Valuation. Broadly, there are three reasons to sell — Business, Management and Valuation.
1. Business — The biggest reason to sell is the realization that thesis is not playing out. For that, one needs to know, before and during investing, what’s the thesis? When you are wrong, you are wrong. What most people do is to wait before getting even to sell — This is usually more costly than in time and capital than taking the loss the moment one realized thesis is not working.
I have been through this at least twice in past — Biggest example is Bajaj Consumer where I was stuck with the idea of them being a market leader and the thought that this will translate it into other products leadership — Never happened and was stuck with it for years of no return before selling at a capital loss.
Another example from my own portfolio is J&K Bank where I bought thinking business will improve but never did, lost 50% of invested capital and 3 years of opportunity cost.
There can be many case studies built on this — Jain Irrigation (Never owned it), Prime Focus ( Maybe) and a lot more.
One of the best books to read on this is Dead Companies Walking by Scott Fearon
2. Management — This is something which has been a major learning in last 4–5 years — Run away at the slightest hint of any corporate governance issue, no matter who is buying or even if the promoters themselves are buying. Street talks in this regard is very helpful. Use valuepickr forum to see if there is anything in the market negative about the promoters. I have done many mistakes here — Some I sold, some I didn’t and those are the ones still in my portfolio, teaching me a lesson everyday.
Some of the examples where I have realized my mistake and still didn’t sell are — Sankhya Infotech, Pincon Spirits.
Some which I sold at profits despite being horrible investments due to corporate governance issues — Vikas Ecotech.
This is the biggest issue in India and one needs to be protected against frauds. Which are plentiful since the discovery is always there, bit reaction happens very fast.
Usual google searches as promoters+fraud, promoters+ insider, promoters + thieves is very useful here. This article from Dr. Vijay Malik is a gem as well –
Also, read online stock forums. People know. Always. Pay heed to those concerns. Know that it’s not the fraud that kills a company, it’s the perception of fraud that does it. And there aren’t no smoke without fire.
Other major issue where you should run away is capital mis-allocation — People are not always frauds. But they are many a times bad at capital mis-allocation — This is more common than outright fraud, but equally, if not more dangerous. I can recall many names here — Many in BFSI sectors, many in consumers, pharma. Managers usually overestimate their capital allocation skills. I see this playing out loud in private space almost everywhere — Oyo to name one.
Luckily this is one mistake I have been able to avoid.
One of the best resources to understand capital cycle — Capital Returns
3. Valuation — I have always been wary of paying high valuation and there is a lot of mistakes of omission here, but then, the mistakes that I think I really made were not selling when valuations went crazy and I didn’t sell because I thought they are long term holdings.
Another mistake here is to value cyclicals on P/E, EV/EBITDA or other similar measures and buying in good times and selling in another. Of the most talked about cases, HEG/Graphite India comes to mind where people bought at the wrong times. Here, lack of knowing what one is really buying leads to paying higher multiples — so valuation mistakes compounded by business mistakes.
I have realized you need to sell time to time when valuations are 2–3x of 5 years average or higher and then wait for cooling off — Because they will happen. Some examples are -
SKM Eggs — Still hold it. The consumer story hasn’t panned out the way I thought it will and it actually gave me an exit opportunity at 2x in 6–7 months of investing. This is a combined mistake of valuation and business misunderstanding.
Dixon Tech — Bought this at practically the lowest and when it went 60x PE, still didn’t sell knowing fully well it will fall and provide more opportunities at lower valuations.
Bought both of these very recently, but the returns could have been much better if I have been prudent in selling. This is the trickiest one.
Once you have decided to sell, sell it. You can sell it staggered if that’s what suits you. I prefer selling at one go and then not thinking about it (Yes, stocks do have a habit of going up when I sell them!).
Let me know your views on this.