Amit bought a stock last year. In due course of time, it has performed quite well and the price has since then doubled. Amit is happy as he is sitting on 100% profits.
To decide on the future course of action – (a) whether as a prudent investor should he sell and book profits or (b) alternatively should he continue to hold – Amit seeks advice from some of the experts in the field.
Conflicting advice
Unfortunately, he receives conflicting opinions, which does nothing to solve his dilemma – to sell or to hold.
One set of experts advise that one should regularly book profits. It is not good to be emotionally attached to a stock. As soon a reasonable level of appreciation is achieved, one should sell and book the profits. This will ensure regular build-up of the corpus and protect oneself against downturns in the market.
On the other hand, there are experts who are of the opinion that if one were to sell the stock the moment it gave say 30% return (or some other level one may decide), one will never have a multi-bagger in his portfolio. They advise that one should buy businesses not stocks. And once a long-term call has been taken on the business, one should forget about the short-term appreciation (or depreciation).
Solution to the dilemma
Let’s try and use the basics of investing and see if we can arrive at a consistent answer to this dilemma.
Why do we invest? We invest to make money. We don’t want our cash to lie idle.
Why do we want money? We have certain aspirations (say a car, a house) or needs (child’s education, marriage), which the money can fulfill.
Hence, if we have a need today, then the question of holding on does not arise. We have to sell the stock and fulfill the need.
However, if we have no immediate need of the money, then we have to remain invested. The question then arises - whether to book profits in the current stock and move on to a new stock or to continue to remain invested in the current stock?
Now the answer to our dilemma becomes quite simple. If there is another opportunity, which is expected to perform better than the current one, then switching makes sense.
In other words, we should be guided purely by the future growth potential of the stock vis-à-vis other options. If there is sufficient growth likely in the business and the company, selling the stock would defeat the very purpose of investing (even though it may have already appreciated). Companies with good management have continued to perform and grow consistently over long periods of time. And this has reflected in performance of their stock. Just because a stock has doubled does not mean that it cannot double again.
On the contrary there have been blue-chip companies, which were deteriorated over the years – reasons could be many – poor management, change in business environment, technological obsolescence, etc.
So, again, just because the stock has doubled doesn’t mean that it will continue to perform well in future too.
‘Critical analysis of the Future prospects’ of the company - and not how much the stock has appreciated - should be our touchstone in deciding whether the stock is still gold or not.
To decide on the future course of action – (a) whether as a prudent investor should he sell and book profits or (b) alternatively should he continue to hold – Amit seeks advice from some of the experts in the field.
Conflicting advice
Unfortunately, he receives conflicting opinions, which does nothing to solve his dilemma – to sell or to hold.
One set of experts advise that one should regularly book profits. It is not good to be emotionally attached to a stock. As soon a reasonable level of appreciation is achieved, one should sell and book the profits. This will ensure regular build-up of the corpus and protect oneself against downturns in the market.
On the other hand, there are experts who are of the opinion that if one were to sell the stock the moment it gave say 30% return (or some other level one may decide), one will never have a multi-bagger in his portfolio. They advise that one should buy businesses not stocks. And once a long-term call has been taken on the business, one should forget about the short-term appreciation (or depreciation).
Solution to the dilemma
Let’s try and use the basics of investing and see if we can arrive at a consistent answer to this dilemma.
Why do we invest? We invest to make money. We don’t want our cash to lie idle.
Why do we want money? We have certain aspirations (say a car, a house) or needs (child’s education, marriage), which the money can fulfill.
Hence, if we have a need today, then the question of holding on does not arise. We have to sell the stock and fulfill the need.
However, if we have no immediate need of the money, then we have to remain invested. The question then arises - whether to book profits in the current stock and move on to a new stock or to continue to remain invested in the current stock?
Now the answer to our dilemma becomes quite simple. If there is another opportunity, which is expected to perform better than the current one, then switching makes sense.
In other words, we should be guided purely by the future growth potential of the stock vis-à-vis other options. If there is sufficient growth likely in the business and the company, selling the stock would defeat the very purpose of investing (even though it may have already appreciated). Companies with good management have continued to perform and grow consistently over long periods of time. And this has reflected in performance of their stock. Just because a stock has doubled does not mean that it cannot double again.
On the contrary there have been blue-chip companies, which were deteriorated over the years – reasons could be many – poor management, change in business environment, technological obsolescence, etc.
So, again, just because the stock has doubled doesn’t mean that it will continue to perform well in future too.
‘Critical analysis of the Future prospects’ of the company - and not how much the stock has appreciated - should be our touchstone in deciding whether the stock is still gold or not.