When To Sell A Stock? Lessons From The Greats by Steven Towns
For many investors, dyed-in-the-wool value investors especially, buying a stock is not as simple as inputting a buy order – as in value investors need to have done their research and fundamental analysis, the company ought to have for instance some sort of moat (and be a compounder whose shares are priced reasonably if not cheaply) or be trading at a discount to x variable(s) [e.g. margin of safety via current or tangible assets; resource conversion opportunity], and one must have the capital available to establish a position. Further, how much stock does one buy at first; how much of an order will get filled for a smaller cap company? Although, once a position is established and fully-invested, it ought to be more of an auto-pilot mode in the sense of turn off the “quote machine” and let the company work for you.
Once invested, an investor should of course still follow the company for earnings-related announcements, press releases, its proxy statement, etc. Conference calls, investor presentations, and management discussions can yield important information that may reinforce one’s conviction or lead to additional research or monitoring of developments. Thus, it’s auto-pilot to an extent, although we’ll see below that all of this extra work theoretically may not be absolutely necessary. Depending on one’s portfolio, an investor may have capital available for further investments. So the used car lot walk (I opted for “used” since I doubt many value practitioners are studying IPOs, at least not these days in the U.S.) may be a constant undertaking. Positions of course can also be closed in favor of a better opportunity. Amid this whole process, position sizing is an overlooked but crucial factor in investing. I’m reminded of the frequent references to the story of Soros and Druckenmiller (for example, see here) and most recently my friend, Elliot Turner of RGA Investment Advisors, interviewed Joe Peta (author of Trading Bases: A Story about Wall Street, Gambling and Baseball), and position sizing was among the key topics.
Let me now comment on the title: when to sell a stock? How many people today remember the prolific and insightful author, John Train? I’ve always enjoyed, and every so often flip through, Train’s Money Masters and The Midas Touch, as well as his Famous Financial Fiascos. I have very little position turnover, as I am more apt to add to my concentrated holdings and make periodic new investments, than to sell either partially or to completely exit. Thus, for me, I aspire to be more like Buffett and Fisher (hold
“forever” — admittedly truly forever is essentially for wholly-owned companies like GEICO, See’s, and Furniture, in Buffett/BRKA’s case) than to sell at say +50% or if a compounder’s valuation gets slightly ahead of itself (Sanrio, which I wrote about recently, did rather quickly get to nose-bleed levels). Train, in The Midas Touch, a book published in 1987 all about Warren Buffett, describes him as 85% influenced by Benjamin Graham and 15% influenced by Philip Fisher. Selling is arguably much harder (to execute) than buying since it evokes so much more emotion, thinking, and reasoning.
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Of Buffett’s/Munger’s many key virtues their need to sell less than others in their shoes as managers (and allocators) of capital is intriguing. Less is more for them. Circle of competence narrows the universe of investment candidates; employing high hurdles surrounding such parameters as: moats, high returns on (minimal) invested capital with no/low leverage, and of course, margins of safety, all mean that in many cases investments can be made at very favorable prices and potentially held “forever.” Now, that is not to say that other value strategies are inferior if they incur more selling (debt security purchased at $0.20/$1.00 closed out at $1.00/$1.00), as a 5x in a couple years time is markedly better than one that’s realized in a decade (although the latter is nevertheless an impressive return compounded at 17.5%). One should keep in mind Howard Marks’ observation: those investors that say they don’t do this or that strategy only means opportunities are created for those that will. Therefore, besides investable cash itself, ideas and information are the lifeblood of an investor. See John Mihaljevic’s Manual of Ideas, Nate Tobik’s Oddball Stocks, and Evan Bleker’s Net Net Hunter.
Back to the “when to sell a stock” question and the above mentioned John Train, I will close with an excerpt from a 1978 Forbes article of his entitled “The Man Who Never Lost.” This apparently concerns Train himself, who after returning from WWII, consistently lost money in the market no matter what strategy employed and even in outright bull markets. That is, until 1961 when at the Merrill Lynch office in Houston he is told of an investor who had never lost money (annually) for nearly 40 years, who happened to be in the office at the time in one of his rare office visits. Train begins his article with:
Everybody who finally learns how to make money in the stock market learns in his own way.
The man who never lost is a rice farmer and hog raiser.
He equated buying stocks with buying a truck load of pigs. The lower he could buy the pigs, when the pork market was depressed, the more profit he would make when the next seller’s market would come along. He claimed that he would rather buy stocks under such conditions than pigs because pigs didn’t pay a dividend. You must feed the pigs.
It turns out the farmer was a market timer, but not that kind of market timer. Train befriended him and learned much of his investing philosophy during a sixteen year friendship that included duck hunting (the farmer, a Mr. Womack, died in 1977). In short, Mr. Womack would buy during a bear market — which he recognized when the market tanked and there were yet new lows accompanied by the experts predicting more declines. His strategy: select 30 stocks below $10/share (solid, profit-making, unheard of little companies like pecan growers and home furnishings companies that paid dividends) from the Standard & Poor’s Stock Guide.
He took a farming approach to the stock market in general. In rice farming there is a planting season and a harvesting season; in his stock purchases and sales he strictly observes the seasons.
Train goes on to explain that he never seemed to buy at the very bottom or sell at the exact top, but he was happy to be in the respective range of both. The farmer had conviction to add to his bargain positions when they lower, even sharply lower.
I suppose that a modern stock market technician could have found a lot of alphas, betas, contrary opinions and other theories in Mr. Womack’s simple approach to buying and selling stocks. But none I know put the emphasis on ‘buy price’ that he did.
Train then comments that he’d come to realize that “many things determine if a stock is a wise buy.” However, importantly, during a depressed market, simply buying at the bottom range “will forgive a multitude of misjudgments later.” The S&P 500 declined 29% in 1974 following a 17% drop in 1973; it gained 32% in 1975 and 19% in 1976, while it declined 11.5% in 1977 and was up 1% in 1978.
So, when to sell a stock? That is, assuming one doesn’t intend to hold “forever.” Consider this:
During a market rise, you can sell too soon and make a profit, sell at the top and make a very good profit, or sell on the way down and still make a profit. So, with so many profit probabilities in your favor, the best cost price possible is worth waiting for.
“The Man Who Never Lost” appears in full in John Train’s The Craft of Investing. I don’t necessarily recommend this book, although there are some nuggets; Train’s other books mentioned above are among his best.