Factors influencing Decisions: A Quest for the proper course of Decision-making in Share-investments

Factors influencing Decisions:

A Quest for the proper course of Decision-making in Share-investments

It has been seen for a long time that human being is not always rational and his decisions are not always objective. For instance, if one watches share market, technically the price of a stock should be reflection of its P/E, P/CF & P/BV values, but such is not the case most of times, because the prices of indices are also governed by various aspect and factors of human mindset- expectations, sentiments and excitement to name a few.

This unpredictability of human behavior has led to emergence of a new field in psychology termed as ‘Behavioral Finance’. Behavioral Finance is the study of roles of behavioral factors in the field of finance, especially investment

It is well-known fact that intelligence is one of the important factors, besides hard work and perseverance for achieving success in life. It is generally expected from an intelligent individual to perceive and understand situation properly, think rationally and reason out everything, before making any decision. Clarity of goal, a well-thought strategy to achieve the same, moderate level of motivation, a disciplined behavior with flexibility to reassess the strategies with new developments is certain other requirements to achieve success. This is applied everywhere, in all decisions and goals including individual’s investment decisions as well.

But since human beings do not live in isolation, therefore there are other factors as well which influence his interpersonal relations, and consequently his decisions. Rationality in a man’s decisions or behavior is not always seen as to be expected from them. For instance, people do make different decisions in the two similar situations or behave similarly in two different situations depending upon their emotive state of mind. Thus, emotion plays a vital role in influencing his behavior and decisions. This becomes more apparent in case of investment-related decisions when taken in relation to the share market.

But debate does not end just here. Human beings are not just born for investment; they have other things to do as well. There are numerous occasions when people make mistakes in investment-decisions mostly under the influence of emotions and stress. It is not possible for a person to be totally immune to his emotions, but once he is aware of the risks involved with emotional instability, one can limit the losses. In this context, fear and greed are the most well-known emotions. There is tendency in human-beings to make more money in short time and this tends him to invest in share-market, even when it is at boom. So when market is bearish, the emotion of fear replaces greed. Human-beings love profit, but hate loss even more. A slightly negative indication brings in a lot of negative emotions and consequently, fear comes in. Initially, investor holds position (while rationally, if he wants to quit, he should book losses at that time only) and once the market’s bottoming out tendency to quit gets bigger (though if investor has been rational, he should have waited for a little longer duration and should have stuck to his position). In this way, it would not be wrong to say that not only fear and greed have negative effect on rational thinking, but they also have adverse effects on the long-term strategies of individual. These two unfortunate passions bring in impulsiveness in the individual’s character and continue to press him to take irrational decisions.

Further, Defense-mechanism of denial used by a person to save his self esteem and his ego are also significant factors which prove dangerous in the long run. An investor is, most of the times, adamant to accept that he has made wrong decision. So, he sticks to his decision and end up holding his loosing position longer than what should have been. The anticipation of ‘being wrong’ by any investor, cuts his losses and enables him to take decisions which help him to recover the loss.

Another aspect of Defense-mechanism of denial is its effect on analytical reasoning. Under emotional state of denial, an individual perceives selectively. He tends to emphasize data and information which confirm his position and viewpoint. It also restricts the individual to rationally analyze any new adverse information. Sometimes, it also generates tendency to overemphasize any subtle good indicator and underemphasize the bad indicators, and so, compel the investor to continue with the loosing position, thus aggravating loses.

These factors always influence the decisions of an individual, but the degree of their influence differs. Now, it depends on the individual how he (or she) manipulates these factors for profit. A good investor is one who not only comes out of loss by applying logical thinking but also makes it profitable one. Moreover, one should not stick to his decisions, if situations have changed. The people with low self-esteem and low EQ stick with their decision and apply defense mechanism. False impression of hope leads them to further losses. They even set aside the direction of necessary indicators.

So, to be a good investor, the proper way to act is not simply to book profit at appropriate time, but also to minimize losses in the adverse situations.

’Never Say Die’

http://ansblog.com/2010/02/factors-influencing-decision-making-process/#ixzz0ehyAKUQA

Buy and Hold — Is It For You?

Let's take a look at what exactly "buy and hold" means. We'll also look at how long is long and when you should sell a stock.

What Does "Buy and Hold" Mean

It's an investment strategy that blends seamlessly with Fundamental Analysis. After you buy a stock, you hold on to it for a while even if its price bounces wildly. You sell only when you have good reason to.

You can see see how this is radically different from a market timing strategy — buy low, sell high.

This brings us to a very important question — how long is long?

Long is relative. From a buy and hold perspective, long would mean at least several weeks. Anything shorter than that would generally fall under another stock investing strategy called day trading.

If you've bought the stock based on the fundamentals, then you should sell only if you have very good reason to. And that brings us to the next important point....

When Do You Sell A Stock?

The best investors are divided when it comes to this question. At one end of the spectrum you have the Warren Buffett camp that says, "Our favorite holding period is forever." At the other end, you had Peter Lynch who held on to most of the stocks in his portfolio for a month or two at the most. His entire list turned over at least once a year. And, he had around 1400 holdings!

It's important to note here that these are big players with billions of dollars in investments. Different rules apply there.

Your decision to sell a stock should be based on the strategy you're using. Since we use Fundamental Analysis, here are our reasons to sell stock:

• When the price of a stock crosses its intrinsic value — the stock is now getting overvalued and with that comes the risk of a sudden drop in price. Time to lock in your profit and exit.



• You realize you made a mistake in your analysis — it happens every once in a while. You find something you don't like about the company or its management. Had you known that before you invested, you would have never bought the stock. If the reasons you bought the stock are no longer valid, it's best to sell. Remove the emotion out of the decision, admit you made a mistake, and sell. You will be better off.



• The fundamentals have deteriorated — the strong past financial performance of the company have now started going south. Evaluate the situation. If it doesn't look like the company will come out of the decline anytime soon, it may be time to sell.



• A better opportunity comes along — you find another company to invest in with great financials and a very attractive price. One small problem .... you don't have enough cash to buy a meaningful amount of stock. Can you sell one or more of the stocks you own that will free up some cash?

The buy and hold strategy does not mean owning a stock indefinitely. Believe it or not, selling a stock is much harder than buying a stock. You tend to get emotionally attached to the stock. It's hard to sell when the price has fallen steeply — you're always hoping that somehow the price will come back up again and you won't loose your money. It's hard to sell when the price rises — you don't want to get in the way of a good thing.

So again, let your stock investing strategy dictate when you should sell. Try and not let emotion get in the way. Remember ... you want to own the stock as long as you don't have a good enough reason to sell it. But if you do have a reason, sell it. Get it over with. Move on.

http://www.independent-stock-investing.com/Buy-And-Hold.html

When and Why to sell. "Rules" for Selling a Stock

When and Why to sell
There is really no "time" to sell; however, there are certainly reasons to do so. Most investors, less successful than you will be, believe that you should watch for the price to rise "high enough" — whatever that means—and then sell it to take your profit. Successful fundamental investors know that "profit taking is often profit-losing."

"Rules" for Selling a Stock
The first rule for selling is . . . don‘t! . . . unless:
1) The company has had an adverse management change.
2) Profit margins are declining or the financial structure is deteriorating.
3) Direct or indirect competition stands to affect the company‘s long-term prosperity.
4) A company‘s success is too dependent upon a single product whose cycle is running out.
5) The company is in a cyclical industry and the cycle is about to start down.
6) You must, in order to maintain adequate diversification.
7) An issue of equal or greater quality offers more gain prospects on the upside and less risk on the downside.
8) The stock is way overpriced (at least 150% of the five-year Av-erage P/E) and the company‘s earnings are growing at 12% or less. Even then, you might consider holding-or selling only some of it.

Note that, of the eight reasons for selling listed above, only the eighth suggests that you might sell to take a profit-and then only if: a) the price is way above average; and b) the company is growing relatively slowly.

• The first five of the rules call for chucking losers.  (Defensive strategy)
• The sixth suggests "weeding and feeding" in order not to be grossly over weighted in any particular industry or market sector. 
• The seventh and eighth call for replacing a stock with a low potential only when you can find one as good or better with a greater possible return.   (Offensive strategy)

Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

If I can’t convince you that a market downturn is no reason to panic, maybe the world’s greatest investor can. In his 1997 letter to Berkshire Hathaway shareholders, Warren Buffett wrote:

A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.
The next time the stock market takes a tumble, remember Buffett’s advice. And then go out and buy yourself some hamburgers!

Did Buffett indeed make a mistake by not selling Coke?

Lessons from Buffett’s Decision not to Sell Coke: “I talked when I should have walked”
Written by Greg Speicher on August 2, 2010

In his 2004 letter to the shareholders of Berkshire Hathaway, Warren Buffett admitted that he made a mistake by not selling certain stocks that were “priced ahead of themselves.” The episode contains some powerful lesson that we can use to improve our investment results. 

Let’s look at how the businesses of our “Big Four” – American Express, Coca-Cola, Gillette and Wells Fargo – have fared since we bought into these companies. As the table shows, we invested $3.83 billion in the four, by way of multiple transactions between May 1988 and October 2003. On a composite basis, our dollar-weighted purchase date is July 1992. By yearend 2004, therefore, we had held these “business interests,” on a weighted basis, about 12½ years.
 
In 2004, Berkshire’s share of the group’s earnings amounted to $1.2 billion. These earnings might legitimately be considered “normal.” True, they were swelled because Gillette and Wells Fargo omitted option costs in their presentation of earnings; but on the other hand they were reduced because Coke had a non-recurring write-off.
 
Our share of the earnings of these four companies has grown almost every year, and now amounts to about 31.3% of our cost. Their cash distributions to us have also grown consistently, totaling $434 million in 2004, or about 11.3% of cost. All in all, the Big Four have delivered us a satisfactory, though far from spectacular, business result.
 
That’s true as well of our experience in the market with the group. Since our original purchases, valuation gains have somewhat exceeded earnings growth because price/earnings ratios have increased. On a year-to-year basis, however, the business and market performances have often diverged, sometimes to an extraordinary degree. During The Great Bubble, market-value gains far outstripped the performance of the businesses. In the aftermath of the Bubble, the reverse was true.
 
Clearly, Berkshire’s results would have been far better if I had caught this swing of the pendulum. That may seem easy to do when one looks through an always-clean, rear-view mirror. Unfortunately, however, it’s the windshield through which investors must peer, and that glass is invariably fogged. Our huge positions add to the difficulty of our nimbly dancing in and out of holdings as valuations swing.
 
Nevertheless, I can properly be criticized for merely clucking about nose-bleed valuations during the Bubble rather than acting on my views. Though I said at the time that certain of the stocks we held were priced ahead of themselves, I underestimated just how severe the overvaluation was. I talked when I should have walked.
 
As the following charts show, of the big four, Coke and Procter & Gamble reached the most extreme levels of over-valuation. According to Value Line, Coke sold at an average P/E ratio of 47.5 during 1999, its peak being considerably higher.  Procter & Gamble sold at an average P/E of 30.8 during 1999.

(all graphs show quarterly prices and P/E ranges from 1/1/1996 to 7/30/2010)

American Express

Coca-Cola

Procter & Gamble

Wells Fargo

(click images to enlarge)

 
What lessons can be learned from this?
 
If you’ve read my investing blueprint you know that I am a strong proponent of patient business-like investing for the long-term. This is a proven way to create wealth. However, at a sufficiently high price, all assets – no matter what their level of quality – should be sold.
 
What is sufficiently high? When the price clearly exceeds all reasonable estimates of the Net Present Value of the business’s earnings after taking taxes into consideration. 

What can make this difficult is that the intrinsic value – the net present value of all future cash flows – of a truly great business may be strikingly high in relation to its current earnings. Consider that a 50-year bond with economics similar to those of Coke (ROE of 30% and a payout ratio of 66.67%) would have a net present value of 46x earnings, assuming a discount rate of 8%. (Here’s the data.)
https://spreadsheets.google.com/pub?key=0AqDABX1wIfxZdHJzb0tlZHh5Y1gwNUI3WXc0M0lLRXc&hl=en&output=html 
 
However, unlike a bond where the coupon is set and contractually obligated, a holder of equity has no future guarantee other than his judgment about the competitive advantages of the business.  At the peak of the bubble, Coke’s price appeared to more than fully reflect the next 50 years of earnings and then some.
 
Plus, the proceeds of the sale could have been redeployed in cheaper assets, thereby raising the intrinsic value of Berkshire Hathaway. The challenge is that, unless you have a specific immediate purchase in mind, you never know how long you will need to wait to re-invest the funds of a sale.
 
If you buy or hold an overvalued security it will materially impact your future performance. Many stocks purchased during the Internet Bubble have shown a large increase in earnings with no progress in the price of the stock.
 
Consider an example. In 1999, Microsoft earned $.70 a share, sold for an average P/E of 49.8 and traded between $34 and $60 per share. Ten years later during 2009, it earned $1.62 per share, more than doubling its earnings, but sold for an average P/E of 13.4 and traded no higher than 31.5. Lesson: don’t overpay – it’s costly!
 
Confirmation Bias
 
Beware of confirmation bias, which Wikipedia defines as, “a tendency for people to favor information that confirms their preconceptions or hypotheses whether or not it is true.” Buffett was long on record as saying that his favorite holding period was forever, going so far in his 1990 shareholder letter as to call Capital Cities/ABC, Coca-Cola, GEICO, and Washington Post his “permanent four”. The risk with confirmation bias is that you are liable to act irrationally even at the expense of your own interests.
 
How Much Cash Will You Get Back?
 
If you are a businesslike investor, you should actually expect that a business in which you invest will deliver more cash than you put in. This is how Buffett operates as is evident from the comments about how much of his cost for purchasing shares in the “Big Four” he had already received. This is a lesson in how to think in a businesslike fashion about investing.
 
“The glass is invariably fogged”
 
Investing – whether deciding on a new purchase or whether to hold an existing investment – is always a business of judgment fraught with many uncertainties: “the glass is invariably fogged.” Accept this and get on with it by putting a premium on hard work, exceptional research, and following a rational investing process with great discipline.
 
What are your thoughts? Did Buffett indeed make a mistake by not selling Coke?

Read below or add a comment...

1. M. Ofenheim

   August 3, 2010 at 4:19 pm

   I don’t believe he did make a mistake by selling Coke. I one thing I learned reading and listening to Buffett is that all currencies are a race to the bottom. A dollar will simply buy less in 20 years than it does today.

   I doubt Coke will outperform the S&P during the next 5-10 years, however a business like Coke is one of the few franchises in the world that possesses true pricing power. Coke will sell just as many cans, bottles and syrup, if not more and at a higher price due to natural inflation. As result the value of the business reflected in the total market cap should be preserved.

   Of course we need to add the following caveats:
   1. Is there Competant management?
   2. Are they enhancing the existing brands?
   3. Are they adding brands either thru internal development or fair valued purchases of outside businesses (i.e. Vitamin Water)?
   4. Are they increasing shareholder value (share buybacks, increasing dividends)?

   Reply
2. Drew Kennedy

   August 4, 2010 at 10:57 am

   Consider capital gains taxes before selling.

   Imagine you bought a company for $500, thinking its fair value is $1000. If the company is currently trading at $1500, you would say it is overvalued and might consider selling. If you sold, and the capital gains tax rate was 30%, then you would owe $450 in taxes and have $1050 after tax.

   By selling you gain the ability to invest the cash elsewhere. But if the business you are selling is Coca-Cola, Gillette, or American Express, it will be hard if not impossible to find a better business. Even if you know of similarly great businesses, there is no guarantee that they will be cheap.

   On the other hand, by selling you lose out on any dividends, and real business growth. You will also be losing purchasing power due to inflation (should you hold cash). Finally there is no guarantee the price will fall sufficiently to make the business a bargain once again.

   If the business is terribly overpriced, your taxes will be low, and you have better companies at cheaper prices to invest in, then the decision is that much easier.

   Reply
3. Drew Kennedy

   August 6, 2010 at 10:49 am

   My math was wrong.

   The tax of $450 was based on 1500-(1500*.30). I incorrectly included the total sales price and didn’t take into account the purchase cost.

   Reply

http://gregspeicher.com/?p=841

How to Learn From When Buffett Sells

Adopting Buffett's very-long term perspective can help individual investors focus on what is important, says Morningstar's Paul Larson.

http://www.morningstar.com/Cover/videoCenter.aspx?id=548155

Value investing – When to Sell or Hold?

A good discussion on when to sell in another blog.

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12:30 pm
April 10, 2012

matthew

Member
posts 13
9
Yes, I did this on Aeropostale. Approximately a 32% gain I got on that bad boy.
Reasons I sold, it had trouble getting past $21-$22, and then Barclay's raised there price target to $25 so more investors bought and price went up a bit. I took this chance and sold it, and it has now went back down after today -5%. Keep in mind that I sold it early basically because my intrinsic value was around $23 and I figured i'd rather sell now than risk more just for a small additional gain.

If I had not sold it then I would have been stopped out as during the price consilidation period I put in a stop loss @ $21
10:55 am
April 10, 2012

Jae Jun

Admin
posts 1408
8
do any of you sell after a big fast run up even though it is below intrinsic value?
6:29 am
April 1, 2012

nell

Member
posts 88
7
Some reasons to sell..


1. intrinsic value < price -> no margin of safety
2. business quality goes south, management issues etc.
3. better opportunity


One good reason to buy more is when market tanks but intrinsic value of your specific company keeps growing..

Best wishes,
Nell
10:58 am
March 31, 2012

BugMan

New Member
posts 2
6
I'm fairly new to this, and I, too, see selling as the hardest part.

One thing i've thought of that makes it easier is compare your current holdings to what else is out there. If are holding onto a good company, and you figure it has the potential to go up 12% per year, but you see other companies out there that have the potential to go up 25% per year, then sell your current stock and buy the other ones. It's not that the old company isn't good — it is — it's just that there are better deals out there.
8:03 am
February 27, 2012

gstyle

Member
posts 4
5
I am fairly new to value investing so I find it good to know other have had similar thoughts to my own!
2:17 am
February 25, 2012

Jae Jun

Admin
posts 1408
4
selling is defnitely harder than buying.
One of my weak points as well. If I had a partner, I'd find someone who was better at selling than buying. It would be a great combination.

But to sell, you would have to re value a company regularly.
If there isn't much upside to intrinsic value, then I'm willing to sell at 10% below intrinsic value rather than hanging on.
Companies like GRVY, I am happy to hold even if I'm up 100%.
8:17 pm
February 22, 2012

jalleninvest
Coronado, CA

Member
posts 22
3
Post edited 8:20 pm – February 22, 2012 by jalleninvest
G.raham came up with the 50% or two years towards the end of his life, in that interview that is bandied around the internet some. I am not at all sure that he practiced that in the Graham Newman closed end fund he ran. In one case, he did not, and that was GEICO which they bought half of in 1947 or 1948. They ended up having to distribute the shares to the shareholders of the fund, and it increased 54,000 per cent or something like that. Many became multimillionaires, quite a feat back then.
Walter Schloss, who died the past weekend at age 95, talked about selling. According to him that was the hardest part of this business, trying to figure out when to sell. He didn't like paying short term income tax rates and tried to hold stocks for a number of years. He commented ruefully several times about buying at $30, selling at $50 and watching the stock go to $200, etc. He recommended a new company to Graham that had wonderful prospects. Graham turned it down, saying it wasn't their kind of deal. It was Xerox, of course, but Schloss said Graham would have sold it at a double anyway and missed out on the big increase.

If it was easy, everybody would do it!
9:23 am
February 21, 2012

Graeme
Austin, Texas

Member
posts 162
2
Yeah, this is always a fun question.

For me what I do is I break up my holdings into different categories. For example, I have holdings that I bought at a good (not great) but good price, but they pay me dividends, and if they keep acting as they have for years, they should be increasing my dividends every year. I get a bit of return on the stock price increase, but a great return over many years with the dividends reinvesting. So my sell thesis on these guys is pretty firm: as in, I wont easily do it.

But then I have holdings that I would consider a deep value: selling at a deep discount to book value, or below NCAV or in a really beat up industry. These are the shares that I have a target price for: as in, I will sell when they hit that specific price. There is not a whole lot that would change my mind and make me hold on to it longer. And sometimes that target price is 50% above my purchase, 100% or even more.

So you need to judge for yourself whether the business you bought shares in is now fairly priced at it's 50% gain or if it still has room to go.
4:33 am
February 21, 2012

gstyle

Member
posts 4
1
Hi,

I was pondering the concepts of selling a value stock or holding it for longer. I understand that Ben Graham had a strict rule of selling after a 50% increase or after two years, whichever came first.

A stock brought at value brings the 50% gain, but if this stock is in a strong company with good prospects for the future, should it still be sold? At this point, do you make a decision to strictly adhere to Ben Grahams teachings or evolve to be more like Buffett in buying a good company at discount and holding it for a long time?

If the company in question was a 'cigar butt' then selling after its gain seems more obvious than for a value stock in a good company.

Thoughts / comments
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http://www.oldschoolvalue.com/blog/forum/value-investing/value-investing-sell-or-hold/#p4033

The investor with a portfolio of sound stocks should expect their prices to fluctuate

The investor with a portfolio of sound stocks should expect their prices to fluctuate and should

• neither be concerned by sizable declines 
• nor become excited by sizable advances. 

He should always remember that market quotations are there for his convenience,

• either to be taken advantage of or 
• to be ignored. 

He should never 

• buy a stock because it has gone up or 
• sell one because it has gone down. 

He would not be far wrong if this motto read more simply: “Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop.”