Stick To Stronghold

Never be in a hurry to collect quick profits, holding on to stocks might help:

Last week, a reader commented to me about his own investment behaviour—“While I often find good stocks to invest in, when I look back, I find that I usually exit them too early. How do I prevent this?”

In my reply, I told him this behaviour is not uncommon, and usually happens under one of two circumstances:

1. Many investors exit a share when it dips sharply downwards, whether due to a disturbance across equity markets, or due to a disruption in the company’s profits, as reported in its quarterly numbers. The former problem is easily dealt with—market sell-offs give one an opportunity to buy into companies one favours. When it is the latter, one needs to assess whether it is an early warning of some deep problem in the company’s business, or a one-off problem. Normally, it is the one-off incidents that cause prices to dip or spike sharply. Deeper problems tend to surface slowly, and give the investor several quarters to decide whether he wants to remain in the share or get out. In other words, sharp drops in the price of a share are a time to re-look at the company’s performance, not necessarily a time to react by getting out.

2. Equally common, an investor says—“I bought this share for Rs x, it has now reached my target of Rs. 2x (or whatever target he has). Let me take my profit and exit”.

This is bad! Not because I have anything against price targets, but because such targets need to be related to the performance of a company, and not to the price at which the share was purchased. The moment one starts thinking this way, one’s price target for the company should change at least every quarter, when the company presents its report card. If the company’s performance is likely to be affected by any external changes, such as commodity prices, interest rates, or governmental regulation, then changes in these must cause one to reframe the price target, too.

I try to slot every share I am following into one of these three categories—‘BUY’, ‘SELL’, and ‘HOLD’. Sharp price changes and quarterly results are compulsory reasons to examine every share, and check whether it needs a category change.

If a share suddenly shifts into ‘SELL’ category, because the price has risen sharply, or circumstances have changed, that’s the easiest thing to deal with!

One-off incidents cause prices to dip or spike sharply. Deeper problems tend to surface gradually

If a share I own moves into ‘BUY’ zone, say because its price has dropped, that’s actually a wonderful place to be in—one has been holding the share a while; hopefully one understands the business a bit better than when one first bought it; and now it is available for less. It’s like a discount on your favourite flavour of ice-cream. Time to order two scoops, rather than one. Or, worse, start thinking, “must be something wrong with strawberry ice-cream, if they’re discounting it. Better stick to that boring vanilla.”

And shares in the ‘HOLD’ band? I love shares which coast in this band for years—even if my broker doesn’t. If I bought them at a good price, and the company’s earnings keep rising steadily, their price rises too, without sending price-earnings ratios into the ‘SELL’ zone. As long as the bulk of one’s shares are in the ‘HOLD’ zone, one’s portfolio can be very responsive to new opportunities: since one does not look at such shares as screaming ‘BUY’s, one is not too unhappy about exiting such shares to invest in new opportunities one sights, when an attractive, fresh opportunity presents itself.

In the absence of such events, don’t be in a hurry to take your profits. “HOLD”, if I might coin a cheesy phrase, “IS GOLD”.