Activist Short Sellers
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Defining how to deal with time horizon and when to sell one’s stock is a challenge for every investor. Most practitioners would agree that buying is comparatively easy, but that selling can be more difficult. Selling discipline is a constant challenge, and this article tries to explore several systematic ways to go about it.

Your selling strategy will in large parts be an expression of your investment horizon and consequentially of your overall investment strategy. A long-term value investor will have a different time horizon and selling strategy than an M&A arbitrage investor. For selling strategies, there is no one strategy that fits all investment styles.

Generally speaking investors buy assets that they perceive as undervalued, and sell the assets once they reached or exceeded fair price. A question comes to mind: When will assets appreciate to trade at fair value?

1. In order to answer “When”, you must answer “Why”

In order to understand when the price of your asset will move, you want to understand why it should move. If you have a firm understanding of what events will make the stock move, you can attempt to gauge when it will happen, thereby deducing potential timing for your selling strategy.

Is it that improving financials will be slowly recognized by the market? Will another company buy out the firm and pay a fair price for it? The question why is closely related to the concept of catalysts; mostly investors connect the reason why a stock would move to a catalytic event, such as a merger, spin-off, buy out, or even estimate-beating quarterly results.

2. Sell after the Catalyst

If your investment strategy is driven by finding a firm answer to the question of why the stock price should change, you can adjust your selling strategy according to the catalyst you expect.

For example if you identified a company, that you thought was trading substantially below fair value, and you also identified the company as a perfect take-over target for private equity firms, it makes sense to commit to selling the shares once you get a fair bid for the company. You can also have a time-horizon for the catalytic event to take place. For example, holding the company while expecting a take-over bid within the next two years.

3. Value might be its own catalyst

Maybe you don’t even need to understand why the stock should appreciate to fair value so directly. Warren Buffet does not try to find a near-term catalyst, he is happy with the belief that in the long-term the market is indeed fairly efficient. He is quoted saying that in the short-run, the market is a voting machine – implying that irrationalities of its participants go into the price – but in the long run the market acts more like a weighing machine – you can rely on prices ultimately reflecting more or less accurately the fundamentals of the business. If you have an investment approach that ignores catalysts for the most part and concentrates on value only, you probably want to orientate your selling strategy on a price or return target.

4. Target Price

A price target is a simple approach that doesn’t need a catalyst. Identify companies trading below your estimate of intrinsic value and sell once the stock approaches intrinsic value. Don’t forget to reassess your price targets if the prospects of the company you have invested in have changed, but be sure you don’t change your estimates too quickly.

You can have fixed targets or ranges. You can ease into selling or sell your entire position at once.

A simple selling strategy that uses price targets could look like this: you only buy shares that trade below 60% of your most conservative intrinsic value estimate. You pre-commit to selling half of your position between 75% and 80% of intrinsic value and the other half above 85%.

5. Target Return

Instead of having a target price, you can employ a return target. So instead of selling your position when the market price approaches your target price, you could sell the position when your target return is reached.

For example you could evaluate your positions every day, and calculate the annualized return you got for each stock. Every stock that you could sell today and realize an annualized return in excess of 40% you liquidate.

This strategy in and of itself has the disadvantage that you sell your winners quickly, and let your losers run indefinitely, so you might want to augment this strategy with a selling discipline for losing bets as well.

For example in addition to selling those shares that generated a 40% annualized return, you would also sell the positions that lost 20% or more on an annualized basis.

6. Increase winners, cut losers

A strategy that I have observed quite frequently in practice is the idea that you increase winners, and sell losers. How rigid you are in implementing this strategy also depends on your personal preferences.

You could for example set a time horizon in which you expect your investment thesis to play out and shares to appreciate. You could sell the shares that disappointed over your defined time period, and buy more of the shares that performed well.

7. Sell when better opportunities come along

You can also sell stocks when better opportunities come along. In order to do so, you have to have an objective system that measures how valuable an opportunity is.

You can use intrinsic value estimates to do this. For example, for every potential investment you would have an estimate of the company’s intrinsic value. In theory, you would sell your holdings that trade the closest to your estimate, while you increase the positions in stocks that show the biggest discrepancy between your estimates and current market price.

8. Never sell

There are also long-term investors, who just don’t have selling on their horizon. Imagine finding a company that is consistently compounding its intrinsic value and you believe in the long-term growth trajectory of the business.

In that case, you may want to stay in it forever and watch your holdings appreciate over long periods of time. If you have developed that kind of trust in a company, you don’t have to worry about selling shares.

9. Put your selling strategy in context

It is necessary to assess your selling strategy in context with your overall portfolio allocation, your time horizon, your buying strategy, and implementation issues. You also might want to treat losing bets differently than winning bets, or differentiate between the “styles” of investment ideas and have different selling strategies attached to each investment style. It is all about context and if you start to ignore the context of the situation, your selling strategy will lose its value.

10. A plan is better than no plan

As mentioned in the introduction, no selling strategy fits all investment styles. You might want to have categories of investments – for example long-term deep value, or catalyst driven – and have different selling strategies for each investment style. You also might want to combine different strategies that were discussed in this article.

You have to decide for yourself how strict you are in implementing your selling strategy; do you treat sell signals as imperatives or just as a point of

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