If you have invested in large-cap stocks that peaked and then remained stagnant or declined for years, you might wonder whether you should continue holding onto them. As an equity investor, the timing of when to exit a stock becomes crucial, especially if large-cap stocks make up a significant part of your portfolio.
Here's how to decide if now is the right time to sell a large-cap stock.
If you have achieved or are nearing your financial goal
The decision to exit a large-cap stock should be based on reaching or nearing your financial goal. Even if your target timeframe is 1-3 years away, achieving around 90% of your goal could signal a good time to consider selling. This approach is based on the potential volatility of the equity market. If a market correction occurs, you may not have sufficient time to recover any gains. To safeguard your profits, an early exit may be prudent. Consider reallocating your proceeds to secure avenues such as liquid funds or fixed deposits. If you prefer a gradual exit strategy, you can systematically reduce your exposure to equities over the remaining period. This approach aims to balance risk and potential gains.
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Issues with corporate governance
As a company grows, effective management increasingly relies on well-defined systems and processes. The ethical principles exhibited by top management greatly influence the long-term viability of the organization. Failure to uphold sound governance practices can lead to the eventual demise of a large corporation. Examples of Yes Bank, Satyam Computers, and Reliance Communication serve as poignant reminders that corporate governance is a pivotal determinant capable of shaping the fate of substantial market capitalization stocks.
A big red flag to consider exiting a company's stock is the emergence of corporate governance issues coupled with a lack of remedial action. Several indicators may point to challenges within a large-cap company, including volatile financial performance, questionable integrity of management/promoters, and decisions that primarily benefit top management at the expense of investors. In such instances, it is prudent to consider exiting these companies at an appropriate valuation.
Consistent lack of strong profitability
The returns an equity investor earns are largely determined by the expansion in a company's profitability. While the net profit figure remains a crucial measure for assessing a stock, the company's operating profit provides a clear indication of how well the company is managing its core business. If a company consistently reports poor profitability numbers for several quarters, it may be a sign to start considering selling such a stock.
Problems other than profits
For a large-cap company, the next level of growth often poses a considerable challenge. Therefore, it is essential for investors to meticulously investigate any signs of stress that have the potential to impede the company's growth. While profitability plays a critical role in determining the performance of a stock, there are numerous factors beyond profitability that require thorough evaluation by investors. Alongside profitability, it is crucial to closely monitor changes in company fundamentals, stagnation in topline (revenue) and bottom-line (profit), shifts in the industry landscape, competitive intensity, and the company's ability to innovate new products and services.
When the main factors that drive growth indicate weakness, it can warn of future difficulties. It may be prudent to consider divesting from a company if it struggles to increase its revenue and faces growing competition that could lead to diminishing profit margins. In such a situation, if the company is unable to develop new strategies for growth, it may further exacerbate its growth challenges.
For instance, rising competition in a particular segment is a good trigger to evaluate your stock for exit.
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Stock price is stagnant despite good financials
Despite a company delivering strong financial performance, its share price may not reflect this success. While the numbers may initially conceal any internal issues, the market will eventually start to account for any potential challenges. If future growth becomes constrained by industry headwinds or company-specific issues, the market will begin to factor that in, regardless of the current financial indicators.
Negative government policy
Government policy can significantly impact the growth or hindrance of an industry or sector. As a result, it's crucial to thoroughly analyze any policy developments that could potentially affect your large cap investment.
When not to exit a stock
If a high-quality company is included in your core equity portfolio, it is advisable for investors not to sell off their holdings completely. This is because market cycles and sentiments may create opportunities for generating appealing profits from such top-tier stocks.
When deciding about exiting investments, it's important to consider the potential challenges of re-entering the market. If you make impulsive decisions to exit, it can be tough to get back in. Additionally, completely exiting an investment could invalidate your initial decision to participate in a company's long-term growth.
A common bias, known as heuristic bias, makes it difficult to re-enter a high-quality stock once it has been exited, especially if the stock price does not fall as much as expected after the full exit. For instance, if you have invested in a high-quality business and its share price suddenly increases, it may be wise to trim your position to lock in some profits, while holding onto the core amount of your investment.
