Introduction: Exiting from a stock at right time is one of the principle features of investments. But stock market being extremely volatile, no one can assure the direction of the stock prices. There are several fundamental and technical factors which causes the movement of the prices. In many cases, investors do not have any clue regarding the price volatility as it is not possible to predict the market in a correct manner. We know the parameter which are required to follow before investing, however there are several parameters which are needed during selling of a stock.
Let’s discuss about some key factors which Investors follow before selling or exiting a stock.
- Business Prospect: The future business prospect is a vital point to consider during buying and selling of a stock. A business might have given healthy profits during the past and might have generated wealth to the investors but that does not guarantee that the business will continue to deliver stable bottom-line in coming years. Any changes in macros or in the industry or in the company may hit the profitability of the business and even turn the business into losses. Investors has to be alert about the current scenario of the business. for example- the collapse of Lehman marked an end of a one – hundred- and fifty-years old organization. The reason was macro slowdown and excess of subprime lending in the economy. So, an investor has to analyze all the macro and industry prospect and need to assume the relevant effects on the business and corresponding stock price.
- Debt: Increasing debt in the balance sheet is a matter of concern for the business. A business has two kinds of debt based on the tenure of its repayment. Borrowings less than one year is known a short-term debt while debt with a repayment date above one year is considered as long-term borrowings. A company which is increasing its short-term debt to meet its working capital indicates a cautious sign to the investor. If the company could not increase its profitability, it will not be able to generate higher free cash flow and as a result, the debt amount would pile up. Increasing short-term debt would lead to addition of long-term debt and would increase the interest costs and lower the profitability amount. Reduction in profitability would reduce the earnings per share (EPS) and consequently would drag down the stock price.
- Management: One of the primary aspects of choosing the right stock is the Management and their track record. Being the captain of the ship, the future business prospects depends on the management as they are the decision makers. To choose between the right opportunity costs, and prevailing scope in the market is a great task. This fine line differentiates between a good company and a bad company. Thus, investors need to observe the board of directors with their previous track records. Further, investors have to be skeptical when there is a change in the management and need to know the reason behind the change. A good management in a beaten down sector can lead to higher business prospects while an incompetent management in a flourishing industry would lead to disaster for the company.
- Industry outlook: Industry analysis is important to get a summary of overall market and the business prospect of the peers. Most of the investors choose the stocks, whose business has a higher growth rate than the average industry. While the relative valuations of these stocks stood more as compared to the industry median. Thus, when analysts expect a tepid or zero growth or even de-growth in the industry, investors should lower their position or even exit from their existing positions. If the earnings of the major companies within a particular sector tend to decrease during consecutive quarters, investors should look for exiting the stock because the negative effect of the industry would lead to erosion of margin, higher input costs, lower revenue growth etc. Thus, the top-line and the bottom-line would be adversely affected due to macro scenarios.
- Valuation: Valuation determines the price at which an investor is buying the stock compared to the earnings of the business. For example, the stock of Australia and New Zealand Banking Group Limited (ASX: ANZ) is available at a price to earnings multiple ratio of 12x on trailing twelve months basis (TTM) while the stock of National Australia Bank Limited (ASX : NAB) is available at a P/E of 16.78x. However, both the business operates in the banking segment. The premium valuation of NAB justifies investor’s confidence on the stock of NAB as compared to ANZ. The stock of NAB has generated stellar returns of ~20.36% versus a negative return of 2.51% for ANZ. Investors must put their utmost while selling a stock. A thumb rule suggests, buying a fundamentally good stock at a lower valuation and selling it at a higher valuation. A higher valuation suggests higher investor’s confidence while it does not guarantee higher business probability in the future.
- Sentiment: Despite choosing a fundamentally good stock, investors do not get immediate return from the stock because of the prevailing sentiment of the investors. In case of a bear market, the overall investor’s sentiment remains low and positive news or positive factors do not excite the market as a whole. Even if the company delivers expected results, the stock price tends to get lower due to profit booking. Thus, during bear market, an investor must protect its portfolio and sell the stocks and can enter at a lower price level.
- Bond Market: The return from bond market is another factor which helps an investor to choose between stocks and bonds. During rising inflation, the central bank increases the cash reserve ratio in order to earn higher interest rate. Thus, a bond holder enjoys higher amount as a risk-free interest and simultaneously affects the index’s P/E. Investors chooses to shift a part of their funds to the bond segment which causes lower price to the stocks. Thus, higher bond market return may lead to correction in the stock prices.
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