Friday, June 05, 2009

To sell or not to sell?

Do you ever wondered about this - Imagine you have a stock which you had bought at $1.20. The price now is $1.80. It gives out dividend (not guaranteed, of course) at a rate of 5 cents per annum last year (dividend yield of 4.2%), with possibility of increasing its yield every year. Will you sell the stock for capital gains of 60 cts (1.80 - 1.20 = 60 cts) but forsaking 5 cents or more dividends forever?


Here's a few ways to valuate this:

1. Assuming that the dividend is fixed at 5 cts forever, it'll take 12 yrs (60/5 = 12) for the dividend (if you hold the stock) to cover the present capital gain (if you sell it now at $1.80). Which do you think is better - 60 cts gain now or 60 cts gain over 12 yrs.

Of course, the complications come in when you talk about the possible capital gain (or loss) if you hold the stocks for 12 years. The company might be bankrupt, it might freeze or cut dividends, it might give more and so on. It's never easy to decide.


2. The first method does not take into account the time value of money. It's better to do a discounted dividend approach to account for the time/money relationship.

Below shows my calculation, assuming there is no change in the dividend given per year. I assume a discount rate of 4% (why? that's the inflation rate I assumed) to account for the opportunity cost of holding cash.



After my garbage in garbage out (GIGO) exercise, I end up with a value of 41 cents. The safety factor is to account for any funny things that makes my assumption invalid. If after accounting for the safety factor, I end up with 60 cents, then theoretically I have no incentives to act on either options of holding or selling now. To push me to sell now, I raised the value of 41 cents by 30% to 53 cents - this means if I gain anything more than 53 cents, I'm actually motivated to sell now to lock in my gains.

Since selling now at $1.80 I'll get 60 cents. I'll sell now.

Again, this method does not take into account the possible capital gain/loss of holding the stock for a long period of time. I've already stated in my previous blog post "The false security of intrinsic value" the illusions associated with this kind of discounting method of valuation, so I shall not elaborate more here.


3. Last method is this: I saw another counter with better prospects, so I sell now to lock in my gains, and switch to another counter. What is better prospects? It could be better yield, safer yield, likelihood of higher capital gains in the future, charting etc. Exactly how does one know which counter gives a better prospects - I leave it to you. I do not know myself.

After being played in and out by the market, my inclination is towards method 1 and 3. If it does not scream out buy when using a calculator with only + - x ÷, then you probably need to look elsewhere.

16 comments :

kanglc said...

Why did you buy the stock in the first place? Is it for long-term investment? Is it for short-term trading? Has any of those reasons changed?

la papillion said...

Hi kanglc,

It's a hypothetical exercise. I'm just listing down the things we need to make a informed (and calculated) decision whether to sell or not.

However, that being said, if it's short term trading, the dividends will not have mattered at all because the emphasis would have been the capital gains at along.

It must therefore be for long term investments (at least a few years).

Derek said...

Hi LP,

Kanglc spoke my mind. We should always ask ourselves why we bought the stock in the first place. By doing a proper study prior to the purchase, we will then have a good picture on the fair value of the stock.

One other commonly use strategy is to raise the min. selling price by a certain % say -9%. In this way, one will be able to catch a multi-bagger and also not suffer too much a lose in profit should the price go down. However, what % to set is everyone guess.

Cheers!

Createwealth8888 said...

Learning how to sell is emotionally tough and that is why fewer people like Sales job as they dislike the idea of selling.

la papillion said...

Hi derek,

Even for long term holdings, there will come a time where one will have to sell, unless you intend to keep for the next generation. When the time comes, the dilemma of selling now vs later will still come in.

Say even if we know the fair value of the company. Once it exceeds by 20%, do we sell it? Assuming that the company pays dividend, the question of whether to sell it now to lock in capital gains vs to hold to get further dividends will still come into the picture.

That is the question which I'm discussing in the article :)

la papillion said...

Hi bro8888,

Selling is not easy indeed. Esp when it deals with people. You have to overcome rejection, overcome shyness and a host of other things in order to motivate others to part with their money.

Not easy. Hence, the rewards for sales is unlimited. The limit is how much you can sell only.

Createwealth8888 said...

Easier to buy stock than to sell stock. Holding on to stock gives you hope and the dream of winning big in the future. Selling the stock means you has given up your dream and hope; and has accepted the outcome and the Investing Game for this stock is over. Investors dislike the idea of Game Over.

PanzerGrenadier said...

Hi LP

There's an additional condition I tend to take in when deciding to sell or hold for dividends. That is what else can I invest in? The problem is usually alternative investments for the money freed up are few and fare between.

Be well and prosper.

la papillion said...

Hi bro8888,

Yes, i agree. Hope is a dirty word in investing/trading. Esp the later.

la papillion said...

Hi PG,

Yes, i agree with you. That's why I included an option to think about alternative investment after cashing out. One has to be aware of re-investment risk - there might not be another investment that gives the same yield/or better yield after cashing out.

Anonymous said...

Taken from Dow Theory Letters for your reading pleasure:

MAKING MONEY: The most popular piece I've published in 40 years of writing these Letters was entitled, "Rich Man, Poor Man." I have had dozens of requests to run this piece again or for permission to reprint it for various business organizations.

Making money entails a lot more than predicting which way the stock or bond markets are heading or trying to figure which stock or fund will double over the next few years. For the great majority of investors, making money requires a plan, self-discipline and desire. I say, "for the great majority of people" because if you're a Steven Spielberg or a Bill Gates you don't have to know about the Dow or the markets or about yields or price/earnings ratios. You're a phenomenon in your own field, and you're going to make big money as a by-product of your talent and ability. But this kind of genius is rare.

For the average investor, you and me, we're not geniuses so we have to have a financial plan. In view of this, I offer below a few items that we must be aware of if we are serious about making money.

To read the rest:
http://ww1.dowtheoryletters.com/dtlol.nsf/htmlmedia/body_rich_man__poor_man.html
-------------------------
Recommended % for tikam funds (switching stocks here and there, aka, trading) < 5%. If one is really so chun, then even 5% can roll into large amount.

Bulk of the money still come from compounding.

I concur with MW's monthly investment plan for compounding.

https://www.blogger.com/comment.g?blogID=28021668&postID=847119522151160500&isPopup=true

HH

*at @ 30, saving $4K monthly with 8% compounding is huge amount in 20 yrs time* :)

la papillion said...

Hi HH,

Good article that you linked :)

I can save 4k a month, just not sure where I can earn 8% returns...

Createwealth8888 said...

Compounding at x% is a magic word in growing money. Yes, it is right if one is compounding at x% in a safe instrument like Fixed Deposit.

Not sure, how many people out there got the ability and gut to do compounding in the Market as it means one is putting back every cents back into the market, month after month, and year after year.

It only take 1 or 2 bad year, whatever gains can be wiped off faster than you can imagine.

Anonymous said...

Hi LP,

That figure - $4k is meant for you based on your goal you set for this year. But you need to decide an amount to set aside for investment. Not save for a purpose in future; eg. house/car/wedding etc.

Its 8% inflation adjusted.

Need to search, be convicted and stick on with the plan. Not easy because whatever you read, data are on HISTORICAL. You need to judge if the future returns can be replicated. Maybe http://en.wikipedia.org/wiki/Jeremy_Siegel his books can give an overview.

During my time, even FD were around 5% (nominal) although in the 80s u can get up to 8%! Part of my money was put into insurance which projected 7-8%. This year is the 20th year. Should realised around 4%. FD rate last few years were pathetic, so 4 % is not too bad though not good either.

Those spore blue chips that give good dividends give decent returns but then it was not 20 yrs yet.

For stocks,I favour certain countries, certain sectors for long term investment. It could turn out wrong. Only time can tell. Still learning.

HH

la papillion said...

Hi HH,

I see what you mean by that. Saving up for investing. Alright, at this point it's hard for me to allocate any amt because the near future is so uncertain. But when things settle down, I'll see what is a good amt to set aside purely for investing.

Will do that, thanks!

Sigh, investing is not easy.

Anonymous said...

wait a while more got 60 to 70% of the highest ....sell then buy governmnt bonds when economy recovers . Or fixed deposits or
5 year endownment.