As we have previously encountered, there are multiple areas of investing which are purely subjective and up to each investor. Deciding when to sell falls into this category as well.
Selling is a psychologically complicated task because it forces you to admit you were wrong, and that’s no easy task.
“People excel at validating old opinions with new information.”
There’s a common misconception in the investment community. Many people tear apart those who publicly admit they were wrong and change their opinion. This may be one of the most challenging aspects of investing, but, when done correctly, it may be one of the most game changing qualities to have. It’s not hypocrisy, it’s learning and reflexing.
“Be worried of people who don’t change their mind, because that implies they don’t learn nor think”
The reason why it’s so important to admit one’s mistakes and correct them is because you want to get your portfolio on the right road the soonest as possible. This road:
To rip the rewards of compound interest you not only have to wait a long time but you have to be correctly positioned as well. As observed in the curve, most returns come after 15/20/30 years of compounding. There relies the reason why you need to get on the correct road as soon as possible.
Reasons to sell
Although Warren Buffet states that the best holding period is ‘forever’, there are some points of agreement among authors on when to sell a stock.
Broken Thesis
When an investor buys a stock, it’s future returns hypothetically depend upon the thesis made on the underlying business. If this thesis, responsible for generating the future returns somehow changes or deteriorates abruptly, there’s no case anymore to be made. This is one of the reasons why it is recommended to write down the thesis you are making for a company before buying it, to check if it stands in the future.
Actual Triggers: Business activities or sources of income are changing.
MOAT Disappearance or at Danger
The durable competitive advantage a business has is what allows it to compound capital at higher-than-average rates making it outgrow the economy and its peers. If the MOAT protecting a business gets wiped out or is at danger, it could be better to sell the stock. How could a company continue compounding capital at high rates if competition has free access to its market?
Actual Triggers: Fundamentals deteriorate over time, technological disruption.
Management
When you invest in a company, you are investing in a group of people. No matter the inherent business quality, a truly bad management can destroy any source of moat and future potential. However, after certain threshold, it is fair to assume a company’s management is good, because if not, it wouldn’t have gotten there. Below that threshold, beware of malevolent/dishonest/stupid management.
Actual Triggers: Avoidance/delaying of SEC filings, not thinking long term, actions don’t match words.
Opportunity Cost
If while researching you encounter a company with much higher quality and at a more attractive price than one you already own, that could also be a reason to sell. When buying a stock, make sure the business is the highest quality possible so this does not happen very often and you can be on the ‘good road’ as soon as possible and for as long as possible.
Actual Triggers: Better financials, wider moat, more understandable business model.
Sell into strength and wait for the bear market
This is a quite polemic point but it is raised by some investors. It’s very much like trying to time the market but this applies to drastic situations, trying to take advantage of Mr. Market’s Pendulum. As we know, price fluctuations vary upon sentiment and fundamentals. When a business future suddenly becomes very bright and the financial community starts bidding higher and higher, a stock could double/triple/quadruple or more in few months, even when there were no underlying fundamental changes. That could be a reason to sell because now the business should have to either grow over time to this new valuation (no returns) or get back to its previous level. The latter, if not done soon could be forced by the next bear market (it always comes).
Conclusion
Admitting you are wrong and selling are not sins, the ability to do so is a sign of intelligence. I did not include all of the potential reasons to sell a stock because, as I said, it’s personal. Lastly:
“When in doubt, caution is advised”
Great write up! My focus continues to be on companies that make it easy to hold on to.