The Art of Selling, Part II

There are many strategies to cash out. Let’s start from a few popular strategies before gets to my favorite.

(i) Exit based on profit target. They will exit when it hit certain % of profit. Buy RCE at RM 0.50 and cash out at RM 0.60, a 20% profit. Straight-forward and clean.

(ii) Exit based on moving average or band or any other technical indicator. Sell when it move below 60-day-moving average for example.

(iii) Sell when fully valued. Some will assign Fair Value to a stock, let’s say Genting has a Fair Value of RM $ 9.00. Once the stock price hit RM $ 9.00, the investor will automatically cash out and reinvest in other stocks below Fair Value or wait for Genting to pull back significantly – say RM 6.30 again(30% discount from Fair Value).

(iv) Exit based on index target. A group of stocks, especially index-linked, will generally move in tandem with an index. An index is generally reflecting the investors’ sentiments. Let’s say Public Bank is selling at RM 10.00 when KLCI index is around 1150. 1150 reflects poor sentiments. When KLCI moves by 15% to 1322, Public Bank may move by 12% to RM 11.20. At 1322, some may feel that the sentiments are not strong enough and KLCI may pull back to 1200, an investor may opt to cash out Public Bank at RM 11.20 even though it has not reach its Fair Value ( RM 13 for example) and wait for a lower price again.

More advanced players may look at beta to set their exit point.

(v) No Exit. Warren Buffet said he has no exit strategy as he will buy and hold forever. I’ve written in my previous entry this is not true as he did exit based on this outlook for a business. He will leave his portfolio alone as long as the intrinsic value of the business is growing at satisfactory rates regardless of the performance of share price. He may think American Express intrinsic value is doing fine even though the share price is doing very poorly, shed of 30-40% market capitalization due to recession fear and credit crunch.

(vi) Exit once a sector is no longer in favor. Since commodity is correcting and it could take a long time for investors to unwind their positions. Most of the stocks in the sector will have stigma problem despite of selling very cheap. Petronas Dagangan may be a retail stock selling for a single digit forward-PE but most may perceive it as Oil and Gas stock -- the share price will be whacked if crude oil price were to go down further. Some may opt to get out despite of cheap valuation to avoid sympathy selling.

(vii) Exit based on gut feel or “flexible”. Research has shown this is one of the worst strategies. An investor may be rationalizing why they should not cash out considering the past performance, going against the grain ( contrarian ), one of your best performance stocks, (pride, ego, etc). AIG is one of the oldest insurance companies around, however they did so badly due to sector melt down – it may bounce back but could be years from now no matter how deep is your love for the stock.

(viii) One of my favorites is Trailing-Stops. Trailing-Stops is a strategy to cash out after you have set at certain % pull back from the top. I usually combined valuation in setting my Trailing-Stops.

If a stock has been running for a long time, more than 5 years and valuation reach at sky-high, selling for 30-40 times PE for example, I will set a 25% Trailing-Stop. Let’s say Public Bank is selling at 40 times PE at RM 27 today, a pull back to RM 20 will trigger me to cash out. Some may argue that you should have sold RM 27, well it is entirely up to you. In super-bull run, valuation may reach 100 times PE or RM 67, it is entirely up-to your risk-reward appetite.

Trailing-Stop % pull back is a very personal one. Personally, I will not set less than 20% because less than 20% is consider as a minor correction and has potential of moving higher. However, it very likely when a stock fall more than 20% to fall into bearish territory and has potential to fall further, at 25% will be a good confirmation of the bull is severely wounded. It will take a while before it can climb back – no matter how strong are the fundamentals.

Back to strong fundamental stocks, we can always re-enter a position when significant excesses have been worked out. Back to crude oil example, in 2006, we can exit when it hit US $ 60 per barrel after reached US $ 80 per barrel and re-enter again around US $ 50 per barrel again.

In the latest correction, the trailing-stop should be around $ 110 ( 75% of US $ 147), most have a target of around US $ 100, I think when it overshoot by 20% from US $ 100 target, it may pull back to US $ 80 per barrel, you may re-enter again to ride on the long-term fundamental story of crude oil.