Selling decision

Normally we expect to buy a company stock at a sufficient discount to intrinsic value and sell it when market price is close to intrinsic value.  

As it may not appear, but selling a stock generally is a more difficult decision than buying a stock. It is not only emotional attachment with the company, but fear that price may further go up and particularly a bit more difficult when returns are linked to tax.

As all of us must be aware that capital gain tax on long term stock holdings (more than 1 year) is NIL in India. Hence when we are holding company stock quoting close to intrinsic value, while holding period is less than 1 year, we try not to sell but hold for more than 1 year and avoid paying tax. I have done this few times in past.  

Irrational decision

Recently I started to believe this being an irrational decision. Let me try to explain this:

We try to buy company at significant discount to IV(intrinsic value) and sell at around IV. Our aim is to get maximum return on the invested capital. For example, I bought a company stock with a discount of 50% to IV. if market price goes close to IV, theoretically I am getting 100% return. Assume worst case company is quoting at IV after 11 months from the shares purchased. Now question is - shall I wait for another month to sell off or sell off right now?

If I sell off my holding, my annual returns are 100/11x12=109% and after paying tax of 15%=93%. while from this point of time to 1 more month, quote may go up or down. 

Let us evaluate decision to sell in 11 month:

Positive

• Company is quoting at or close to IV. So my investment purpose is achieved, assuming IV of Company is not increasing.

• Company may not quote around IV in near future, hence selling will not affect my returns in future.

• I will have extra cash to invest in new opportunities.

• Avoiding risk of any new negative development in company, which could affect the IV of company.

Negative

• I need to pay 15% tax on return, hence lowering my return on investment.

• Company quote may go up far beyond IV, due to market irrationality or any positive development, hence I may loose extra return.

• I may not find attractive idea, IV of company increases and I have to keep the money idle.

There may be more positive or negative reasons to sell the stock at IV, irrespective of holding duration. The question is where we go?

My 2 cents

I am starting to believe now, that selling decision shall be based on the current understanding of company, with out considering the market outlook and tax impact.

The reason being I can not predict the future of market or direction in which quote will move. I can only estimate the fair value of the company. If I can not see more value in company, it is better to sell it off and wait for new ideas than hoping market to be irrational and quote far more then fair value. This approach may not be correct for all cases and shall be applied on case to case basis. 

In the end, this reasoning may looks very simple, but very difficult in practice.