When to BUY, HOLD or SELL? (Part 2)

Now, a question that people sometimes ask me with regards to selling is if they should cut loss? 

Well, from a valuation perspective, if we got into a stock which we thought is worth $10 a share at, say, $8 a share, and if the price should fall to $6 a share, should we sell?

OK, let us push this a little and let us say we thought the stock is worth $10 a share but for some reason, we bought it at $12. At $6 a share, should we sell? 

I think you know the answer.

Well, if we need the money urgently because there is an emergency at home, then, we don't really have a choice, do we? 

This is also why we must always use money we can afford to lose for investing. 

If we don't need the money, everything remaining equal, should we not be thinking of buying more if prices fall? 

This is why we must always have a war chest ready!

What we have to remember is that we want to buy at a price we would not sell at and sell at a price we would not buy at. This is a general mantra we should chant to ourselves and embrace its spirit.

Although we might think that $10 for a certain stock is cheap, it does not mean that it would not become $8 or $5 or even $2. 

Of course, if we are sure that our facts are correct and our reasoning is right, we should be buying more as prices fall.

Isn't it risky to buy more as prices fall? Of course, there is risk involved. Cheap could get cheaper. This is why I feel that some knowledge of technical analysis (TA) is useful. 





Purists in fundamental analysis (FA) will pooh pooh at this idea, of course, but unless we have very deep pockets, I think a bit of TA is useful. Anyway, I will talk a bit more about TA later.

Now, since we are on the topic of risk, some would argue that the level of risk associated with an investment should be considered when we talk about valuations. 

So, in the case of a business trust, for example, if it is perceived to be more high risk in nature, we would need a higher distribution yield before we invest in it, wouldn't we? 

I blogged about how this was the case for me when I invested in Perennial China Retail Trust: here.

The same goes with bonds although in the case with bonds, the holders are more lenders than investors and I blogged about bonds before: here and here.

Now, with interest rates rising and we are seeing higher coupons from 10 year bonds, the risks associated with REITs have risen. 

This is why their unit prices have fallen because Mr. Market is now demanding higher distribution yields for investing in a riskier instrument compared to 10 year government bonds. I am not saying anything new, of course.

As anyone can see, there is no one size fits all valuation technique.





So, some have thrown up their hands in despair and decided that they would only use charts to help them decide when to buy and sell. TA gives us a peek into Mr. Market's psychology. 

We then buy and sell based on technical signals which tell us the sentiments in the market. 

Of course, TA is about probability and never certainty. 

TA is about managing probabilities!

There is no exactitude, no matter which approach we choose to use. There are only approximates. 

As long as we are approximately right, we are better off than being exactly wrong. This is good enough. 

This is what Warren Buffett would say. If you have yet to watch the video on why he is the world's greatest money maker, watch the video: here.

Make money using the tools available to every person.

Valuation is a subjective exercise and often, whether to BUY, HOLD or SELL, we have to rely on experience too. 

If there was a magic formula that worked all the time, Warren Buffett and any investment guru for that matter would never have made bad investment decisions in their careers. 

So, it is important to remember this and not become narrow minded when we think of valuations.

Related posts:
1. When to BUY, HOLD or SELL? (Part 1)
2. Recommended books for FA and TA.

When to BUY, HOLD or SELL? (Part 1)

Buying and selling are natural opposites. The reasons for buying a stock and selling a stock, often, are mirror images as well. Intuitively, it feels right. How do we give form to an intuition? More accurately, how do we decide when to buy or when to sell?

Well, we often read about valuations. Some analysts might have a SELL call saying the stock is overvalued. At the same time, some analysts might have a BUY call saying the stock is undervalued. Then, there are some analysts who might say the stock is fully valued and have a HOLD call.

What can we take away from this? Valuation is subjective! Anyone who tells us it isn't doesn't know what he is talking about or does he?

There is a lot of literature on valuation techniques. If we do a search online, we will know that this is true.





So, which valuation technique to use? This is already an exercise in subjectivity. Then, each valuation technique could require us to make certain assumptions which is another exercise in subjectivity. Of course, we are only talking about bottom up approaches here.

What about a top down approach? This requires a grasp of economics, market conditions and industry specific trends, just to name a few things that come to mind. Reminder: the assumption that consumers have perfect knowledge when we discuss certain economic concepts only works in a classroom environment.

If you have zero or very little knowledge of economics and business, you might want to teach yourself by reading these books:

Timeless. US$17.61 a copy.

This book is heavy reading and somewhat pricey.
Click the book and search for
"Understanding Michael Porter:   
The Essential Guide to Competition and Strategy".
This is easier reading and much cheaper.

So, it is not surprising that experts could have differing views all the time. They could make different assumptions in their quantitative approaches and they could have different opinions on the qualitative aspects of businesses which require judgement calls. If experts have such a hard time, what can retail investors like us do?

Value investors are often looking to buy stocks at half of their intrinsic values. If a stock that has an intrinsic value of $1.00 is selling for $0.50, simply, it is a buy. Now, if a stock has an intrinsic value of $1.00 and is trading at $2.00, what do we do? You tell me.

The question is, therefore, how do value investors determine intrinsic value. They use an approach called Discounted Cash Flow (DCF). I shan't go into details here because there are many free online resources that will teach us what is DCF and we will realise that we could come up with different intrinsic values for the same stock. Why different values? We could make more conservative or more aggressive assumptions and values will change.

To understand cash flow, we will have to look at a company's cash flow statement. I blogged about it before and you can read it: here. If you want to read up on valuation using DCF, you could go to Wikipedia: Valuation using DCF.

Some people look at PER, NAV/share and NTA/share of a stock to see if it is undervalued or overvalued. Some might argue that if a stock has a very low PE and trades at a discount to NAV, it is undervalued. Well, it could be. However, if by doing a comparison, we find that other companies in the same industry have similar ratios, then, perhaps, it is just the industry norm.





I remember many years ago, I made a very good trade in Singland. At that time, most of the big name property counters rose in value but Singland was still stuck in a rut. I did a comparison of its ratios against its peers and found it was relatively cheap or, if you like, undervalued. I bought and within a couple of weeks, its price shot up. I cannot remember exactly now but it was quite a handsome capital gain. Singland was a laggard. I did not know if it was absolutely undervalued but it was relatively undervalued.

Different industries have different characteristics. Some are cyclical like the property market. So, given changing market realities, property stocks could see their share price fluctuating as well because their earnings are impacted negatively during down cycles and positively during up cycles. The same could be said of shipping stocks.

If you want to read up on how we could possibly make generalisations about stocks and have an inkling as to their characteristics, you might want to read books which I blogged about before by Pat Dorsey (here) and Peter Lynch (here and here).

By now, if you are still with me, good on you because I am not done yet. We are soldiering on in part 2.

Read part 2:
When to BUY, HOLD or SELL? (Part 2)