The Worst Reason To Sell

Ser Jing - The Worst Reason To Sell (pic) Straight off the bat, the worst reason to sell a stock is: because it’s gone down. To quote award winning investment writer Morgan Housel from the Motley Fool USA, “a stock going down is never a reason in itself to sell.” But unfortunately, many do.

The recent Sunday edition (8 Sep 2013) of our prominent local paper, The Straits Times, had an article titled A Less Painful Way to Invest found in the Invest section. The article was about the psychological benefits of a method of investing called dollar-cost-averaging, where investors invest with a fixed dollar amount every month into any particular investment product or vehicle. .

The article was well-reasoned, with its tagline stating that “dollar-cost averaging may be less effective than lump-sum investing, but it hurts less too when you lose.”

But, the writer, Jessica Cheam, lost me later on in the article.

She wrote that she had invested in a few blue-chip counters in the local market “about a month ago” and then watched her holdings trod the walk-of-shame downwards. She then proceeded to sell her holdings “at a significant loss” after the markets experienced a slight rebound with the intention, going forward, of using her reduced capital to dollar-cost-average into the market over time.

It must not have been an easy time for her, I guess. After all, the Straits Times Index (SGX: ^STI), an index made up of a collection of blue-chips in Singapore, did experience a meaty decline since the start of August. The STI ended 1 Aug 2013 at 3,243 points and is now 6% lower at 3,048 points as of 8 Sep 2013.

While there are indeed a myriad of reasons why individuals might choose to sell their shares, these reasons can be good… or they can be downright befuddling, like ‘because it’s gone down.’

You see, Jessica Cheam had never once mentioned any consideration for the fundamentals of the blue-chips she had previously invested in when she decided to sell them. Instead, she focused on the declining prices of her holdings.

Unfortunately, what she likely did not consider – the fundamentals of the underlying businesses of her holdings –  is very important when trying to make a selling decision.

Stock market participants might be familiar with a quote made by Warren Buffett in 1974, when the USA was mired in a bear market.

Buffett, a billionaire investor from the States well known as being one of the world’s richest men, was asked at the time by Forbes about what he felt about the stock market, to which he replied, “Like an oversexed guy in a harem. This is the time to start investing.”

Buffett’s well-known for loving stocks when others are shunning them, so his quote does not really come as a surprise. But, not many would realise the actual context of the situation he found himself in when he made the quote.

Frank Martin, investment manager and founder of Martin Capital Management (a firm with a phenomenal track record since 2000), wrote in his book A Decade of Delusions that at the trough of the bear market in which Buffett made his “oversexed” quote, his stock holdings were actually halved in value – a full 50% decline.

But Buffett persevered, of course. And the reason for him doing so? The stocks he invested in were likely to have businesses whose fundamentals had not deteriorated despite the obvious decline in their prices.

Over the years, Buffett has repeated ad nauseam on the importance of focusing on a business’s fundamentals when looking at a stock and not making a buy-or-sell decision solely on the basis of its price movement.

Let’s take a look at four companies – Super Group (SGX: S10), Vicom (SGX: V01), Dairy Farm Holdings (SGX: D01), and Raffles Medical Group (SGX: R01) – that soundly trounced the STI’s returns in a close-to-six-years period from 11 Oct 2007 to 23 August 2013 due to great corporate performance. In other words, their share prices went up because of the underlying improvement in their business results.

Company Share Price 11 Oct 2007 8 Sep 2013 % Change
Super Group S$0.88 S$4.37 397%
Vicom S$1.78 S$4.75 167%
Dairy Farm Holdings US$5.10 US$9.97 95%
Raffles Medical Group S$1.51 S$3.11 106%
Straits Times Index 3,876 3,048 -21%

And next, we have a chart showing how their earnings have grown since 2006:

worst reason to sell chart

What we see are four shares that have mostly doubled or more in price as their earnings grew over the years. But were the growth in their share prices a nice, smooth ascent? Hardly.

Let’s take 2011, where the STI suffered an annual decline of 17%. Raffles Medical Group, despite growing its profits at a steady clip through the year (as seen from the chart above), actually suffered a pullback of close to 20% as measured from its peak-to-trough for 2011.

We could also take Super Group, which hit a peak of S$1.61 in August 2011. It subsequently fell by almost a fifth to S$1.32 on the last trading day of the year.

Investors who were shaken by the declines and sold out then would have missed out on the substantial gains that have taken place since.

The argument could be made that an investor could have bought the shares back at the depressed prices even after selling out. But unfortunately, dancing in and out of the market has been shown to be a fool’s errand more often than not.

Foolish Bottom Line

To put it simply, big declines in stock prices are common. But more often than not, these temporary price fluctuations can have nothing to do with the changes, if any, of the underlying fundamentals of the companies.

Peter Lynch, a fund manager who turned every $1,000 entrusted to him in 1977 into $27,000 by the time he retired in 1990, once told the CEO of a company that “if your earnings are higher in five years, your stock will be higher.”

Lynch made his investors rich basing his investing decisions on the business fundamentals of a stock. Buffett made himself rich by focusing intently – almost exclusively – on the business fundamentals of a stock.

I think you’ll know where I stand. How about you?

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing owns B-Class shares in Berkshire Hathaway as well as shares in Super Group and Raffles Medical Group.