In today’s post, I am continuing my discussion on selling aspects for my long term buy and hold portfolio. To me, buying is always a very easy decision. Easy in a sense that I have few quantitative metrics and qualitative aspect that help me decide whether I should buy a given stock. However, I do not have such fixed metrics that tells me, hey buddy, its time to sell. For me selling is a very subjective process. I touched upon few guidelines that help me make a sell decision.

Discussing and presenting my thoughts on this blogs helps this subjective process. The comments and conversations I have with readers of this blog helps (or influences?) this subjective process. When I say influences, I mean influencing the thought process, and not directly sell a stock because my blog reader says so.

Sachin8778 and Aurnsg are two readers who have presented some thought provoking arguments. The common theme is why not sell when it is overpriced. I have summed up their questions are follows:

• Why not sell when market is gives extreme valuation? Use your knowledge of fair value and sell if valuations are higher
• Selling will give higher basis for next capital allocation. i.e. why not think from the viewpoint of maximizing the efficiency of capital allocation (or overall returns from the same capital base).

To Sachin8778: your observations and interpretation are correct. Current market valuation alone is not trigger for me. However, current market valuation does affect timing of executing the sell. E.g. I would have not sold GE Shipping or Reliance Infra in March 2009.

To Arugnsg: your observation is also correct. It is inward looking, completely based on “what is in it for me”.

To me, the notion of being overpriced is very subjective. It depends upon an individual how he/she looks at pricing. Comparing current market pricing with my fair valuations (during buying) is not truly a comparative metric. If you ask different people, all of them will come up with different valuations.

The fair value in my buying process is what I am willing to pay to buy the stock. That’s it. I come up with that fair value by using few different parameters. In general (if not always), this fair value comes around +/-15% of graham’s number. In other words, many times this fair valuation is around 8 to 13 PE ratio. This is not exactly a classical value investing based on intrinsic value, but on similar lines. In this fair value pricing, the margin of safety is in-built. Sometimes, this margin of safety is higher, some times it is lower. So now you know, why I cannot compare current market pricing to my fair valuation. Let me give a simple example.

• I want to buy a house. I will be looking for lowest possible cost. I will try to minimize my cost basis. This is where I say fair valuation I am willing to pay to buy a house. Some other person can say, well, he/she is willing to pay 15% higher to buy the same house, because he/she would have some another advantage like closer to work place, or closer to family, or something else.
• However, when I want to sell this house I will be looking for highest possible cost. I will try to maximize my sell price. At the time of selling, I will not use my buy price as my cost basis. I will not say, hmmm, I bought at 100, let me sell at 130, I am still making money. If it is my primary home, then forget it, I have lots of intangibles which would make it difficult to determine the sell price. BUT if it is an investment property, then my thinking would be different.
• In one scenario, my rental income is still positive. It is improving. The place where this house is located still upcoming and growing. In this case, I would value my sell price at much higher multiples. I would need to believe that valuation is extremely higher. I would not sell at 130. I would not sell at 150. But may be if it is 160 or more.
• In second scenario, my rental income is barely positive, lots of maintenance headache, the place is slowly rotting, or rental incomes are falling due to bad area, or slowly becoming low income region, etc etc. In this scenario, I would be willing to sell at 130 and get out when I am still positive. But probably not at 110, I will spend some time to atleast attempt to get higher price.

So you see, determining a sell valuation is very subjective. This applies to stock positions also. In recent past, I have based my decision to sell/reduce depending upon how it affects my portfolio (inward looking). There are two steps (1) The downside risk to my portfolio triggers what I should do next (2) After indentifying the stock, the next is when to execute the sell.

At this point in time, from the perspective of my thought process, the stocks that I believe could be considered as fairly valued for selling are HDFC Bank, Pidilite, and ABB. I would tend not to consider them extremely overvalued.

So why did I not sell them, and instead chose Reliance Infra? Simply because, I tend to believe that these companies do not pose significant downside risk to my portfolio. Even if I decide to reduce my position (i.e. selling partially), then I would most likely keep cash position. I would have to wait for a while before I fully deploy that cash. Why not keep cash? I have been saying many times, I would be happy to keep cash, haven’t I? Since the post has become long, I will continue this discussion in next post.

selling process, selling stocks, when to sell