The Art of the Fundamental Exit: Knowing When to Walk Away

Entries for longer-term stock investment approaches can be based on either long-term technical trends or more commonly, fundamental data related to a company’s current and projected performance. Despite the plethora of such suggestions, there is often a lack of clear guidance, or even a complete absence, of instructions on determining the timing of an exit from a long-term position.

Logically, whether it’s a short-term technical entry or long-term fundamental entry, many of the “rules of the game” are similar, including the need for clear and unambiguous exit strategies seems paramount for consistently positive investment outcomes. The approach originally used to make an entry decision can serve as a good starting point but there are other considerations that can potentially benefit outcomes.

This article aims to briefly describe six potential exit approaches you could consider, providing some detail and examples as to how to action your chosen approach.

1. Target Price Exit Strategy
   • Setting Targets: Determine a fair value (and thus exit price target) by conducting in-depth fundamental analysis, utilizing metrics like Price-to-Earnings ratio (P/E), Cash flow, debt levels, book value, or longer-term technical levels.
   • On-going monitoring: Regularly track the price against this target. For example, if you calculate a fair value for a stock at $50, and it’s currently trading at $45, you might decide to sell once it reaches or exceeds $50.
   • Other Considerations: Regularly review and adjust the target price, taking into account changes in fundamental factors impacting the relevant sector or market as a whole.
2. Ongoing Fundamental Awareness
   • Ongoing Analysis: Continuously evaluate underlying fundamentals, such as earnings, balance sheets, cash flow, and management quality. Be vigilant not only when next company reporting dates are due but also for the often-unpredictable release of operational updates or changes in guidance.
   • Trigger Points: Identify specific company indicators or information that would prompt an exit.
     An example of this may be a sustained decline in revenue or mounting debt levels, particularly when beyond what was originally expected.
   • Other Considerations: Implementing this strategy requires consistent research and a nuanced understanding of the particular business and industry factors influencing the investment. Having the optimum resources in place to be able to do this is vital and identifying these should be a primary goal of any fundamental investor.
3. Economic & Sector Changes
   • On-going Analysis: Regularly review broader economic indicators like GDP growth, inflation, interest rates, or industry trends. Understand how such changes in these key data points may correlate with the asset price and establish exit criteria accordingly.For example, you may reconsider a position in a technology stock if there’s a widespread shift away from tech spending or growth concerns or regulatory changes that detrimentally affect the sector.
   • Other Considerations: This strategy necessitates a broad understanding of economic cycles, industry dynamics, and how these elements interact with your particular investment holdings. Additionally, it’s worth noting that appropriate resources should be in place to ascertain this as proactively as possible, or at worst in a timely manner. This may assist in preventing excess depreciation in asset price to the point where action is delayed and major capital damage has occurred.
4. Dividend Targeted Approaches
   • On-going Analysis: If part of your entry criteria and anticipated return from fundamental analysis-oriented trades is based on dividend yield to some degree, it is worthwhile to not only look at what is current but also perform ongoing evaluation of the reliability and/or growth of dividends.
   • Exit Criteria: Having established an expected return, it logically makes sense to have criteria in place to help decision making. For example a decrease in dividend yield below a certain threshold or a cut in dividends could be part of your potential exit plan for a specific investment.
   • Other Considerations: As well as vigilance for the timing of company announcements where dividend changes are often announced, awareness of the yield of your current investment compared to others, and industry trends is required, as they could influence the sector and the market as a whole.
5. Time-Based Exits
   • On-going Analysis: Often with time-based exits, there is alignment with a particular impending event. Examples of this type of event include a shift to EVs from petrol-fuelled cars or the impact on assets in the lead-up to an election. Either way, your investment time horizon needs to be reviewed should there be a change in circumstances and the rationale behind your initial thinking on entry.
   • Other Considerations: There is a discipline involved in exiting from a stock position that remains strong even after an event, or the impact of such, has passed.
     With a systematic approach to fundamental entries in place, it is legitimate to review whether other fundamental approach criteria are met and perhaps consider continuing to hold. Without this in place, or if no match with other approaches exists, logic would dictate that a planned exit is an exit, and you should action it as such, no matter how well this specific position has served you to date.
6. Portfolio Rebalancing
   • On-going Analysis: Although not based on a specific entry approach, periodically evaluate your overall portfolio asset allocation is prudent. Reviewing whether the current holdings are still a fit with long-term investment aims and risk tolerance in current and ongoing market circumstances are appropriate rebalancing considerations.
   • Rebalancing Exit Approach: Criteria for rebalancing should be pre-planned and clearly defined. These may require consideration of multiple factors, such as an asset becoming an excessive portion of the portfolio on good performance, or changes in market or economic circumstances that threaten specific portions of the portfolio.
   • Other Considerations: Continuous monitoring of the portfolio is required, and checking continuing congruence with desired asset allocation and your risk profile is vital. Rather than based on a specific entry approach, just to reinforce that the concept of rebalancing is one that is important across all of the approaches described above.

Summary
Although they receive little “airplay” in comparison to technical approaches and exits, the exit strategies within a portfolio based on fundamental analysis entries are multifaceted, frequently interconnected, and equally important to master.

Crafting a proficient exit system demands a comprehensive knowledge of each specific investment holding, and wider market and economic dynamics, in the context of your personal investment objectives, and risk tolerance. The need for a set of written system criteria for all actions, regular monitoring, thorough analysis, and disciplined adherence to predetermined exit criteria are essential.