When To Sell

Ideally, never.

Anne Scheiber rarely sold, and she seemed to do all right.

My style is to invest in reasonably priced compounders which grow into perpetuity and always have an intrinsic value above their current stock price.  That’s a nice idea, but such a company is rare.  To get a sense of this, look at the lists of Fortune 500 companies in 2000 and in 2020. The lists are radically different.  Capitalism is dynamic. That’s the opportunity, and that’s the peril. The Rip Van Winkle investor is a myth.

On the other hand, if the company—or sector—turns into Tulip Mania, I’m headed out the door. In “frothy” markets stock brokers are so ebullient they can’t decide which Jimmy Choo glasses to wear, bow-ties are spinning maniacally, and investors are comfortably numb. I’m happy to sell into a melt-up. However, I decide to sell on a case-by-case basis.

Just as our DCF calculation can identify under priced assets, it can also identify overpriced assets. I’m willing to hang in there, as long as the company continues to execute and maintain competitive advantages.  My inherent bias is to let my winners run.

In his letters, Buffett discusses how—to his eternal regret—he sold Capital Cities when the stock went sky high, only to watch it triple, and triple and triple again. 

The reality is the stock prices don’t go straight up. They are like roller-coasters. They can head up and up and up. In smug self-satisfaction, you pat yourself on the back on your brilliant choice. And then it drops at terrifying speed, and all you want to do is bail—not a good idea in either a stock or 60 mph roller coaster.  Take a look at the history Amazon’s stock since it went public.

Some reasons to sell include:

·       An irrational rise in price with an insufficient change in the underlying economics, e.g. Tulip Mania.

Here’s an example:

I owned a stock in an asset manager that I had held since the 1990s. In mid-2021, the stock headed straight up. In one quarter, the company’s operating margin (operating profit as a percentage of revenues) was 48%. Translation: the company was printing money. This was not sustainable and well above baseline, which had been around 42%, still a spectacular number.  

After the second quarter in 2021, the company had so much money they distributed a bonus dividend equal $3 per share. Wall Street was cheering. Bow ties were spinning at warp speed. 

Here’s the problem.

The company is an asset manager. It buys and sell securities for a living. Why didn’t they use the extra cash to buy back their own stock rather than issuing a special dividend? I took this as a cue to review my DCF, and walked to the exits, selling 75% of my position over the next month. My only regret is that I did not sell my entire position.

·       A change of strategy, particularly strategies that are the “flavor of the month” type; these almost always bad. Companies are chasing the latest trend, or management is suffering from shiny-ball syndrome, like a baby in a playpen.

Sometimes a change in strategy is not bad. You may have heard of a company called Apple that built computers and then decided to build a mobile phone.

·       A change in the economics for the company. This does not have to be a radical change, but can be gradual. An example in my portfolio was a restaurant franchisor which kept making acquisitions. Growth can be great, but it has to be the right growth.  In this case, the operating margins kept declining in small decrements: it was not a wash-out. The changes occurred after a new CEO, who happened to have been the company’s previous CFO, took over the company.  He is a nice guy and obviously understands DCF, but the results were turning tepid.

·       When a company sells out. If the insiders are looking to get out, you should too.

·       A failure in your analysis.  You got it wrong.  Metaphorically, not every kid in your kindergarten goes on to be a Rhodes Scholar. Face reality and move on.

·       A drop in management credibility.  There are two types of people in life: people who deliver results, and people who rely on excuses. Actually, life is more subtle, but you get the point. Quarterly earnings calls where the management reverts to “The dog ate my homework,” are a good reason to exit your investment.

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