Selling, like buying, is no place for emotion or instinct
Whenever a value investor sells a stock in their portfolio, their reason for doing so should fall into one of three categories, all of which are tangible or measurable
If you see a snappy quote about investing, chances are it originated from Warren Buffett. So when Value Capital Partners CEO Sam Sithole observed on the latest episode of The Value Perspective podcast that “I think someone once said you do not have to make your money where you have lost it,” the clever money would have been on that someone being the Sage of Omaha.
Turns out the clever money would have been wrong – albeit very much in the right postcode. “You do not have to make your money back the way you lost it” – to quote him exactly – is actually the wisdom of Charlie Munger, the Berkshire Hathaway vice-chairman destined forever to be described as Warren Buffett’s right-hand man. That cuts straight to the heart of the often overlooked half of the investment equation: selling.
Until you do sell a share, the money you have made (or lost, of course) since buying it is only theoretical – and yet buying invariably commands the lion’s share of investment coverage. Nor, as we discuss in Three reasons value investors will sell a share, is it just the media who are way more interested in buying shares than thinking about why, how and when one might best sell up in order to lock in the most gain.
According to the splendidly titled 2019 paper, Selling Fast and Buying Slow, professional investors can also be pretty casual when it comes to selling stocks. Indeed, having canvassed the views of institutional investors with portfolios averaging $573m (£441m) in size, the authors concluded: “While there is clear evidence of skill in buying, selling decisions underperform substantially, even relative to random selling strategies.”
‘Next great idea’
The paper goes on to suggest selling and buying decisions involve different psychological processes, with experiments finding the latter “more forward-looking and belief-driven” and anecdotal evidence supporting that view. “Extensive interviews suggest managers appear to focus primarily on finding the next great idea to add to their portfolio and view selling largely as a way to raise cash for purchases,” the researchers add.
Given one of the principal objectives of value as an investment strategy is, as far as is possible, to remove emotion from the decision-making process, regular visitors to The Value Perspective would expect us to have rather different drivers when it comes to selling – and they would be right to think so. As indicated earlier, we would say there are three broad reasons why a value investor will sell a stock they own in their portfolio.
First, because the stock has reached fair value; second, because another company has acquired the whole business and you have no choice; and, third, because you have reappraised your view. The future, as we never tire of saying, here on The Value Perspective, is uncertain and there will be times when a material change in a company’s circumstances means the assumptions we made when we purchased the stock are no longer valid.
This is why Sithole referenced the Munger line and he continued: “The danger with trying to persist with something that is not working is that it sucks up the bandwidth for the team involved and even the entire organisation. So when something turns out not to be a good investment, let’s cut our losses and actually reallocate our resources to something else. If our investment thesis no longer stacks up, we walk away.”
Whenever a value investor sells a stock in their portfolio, their reasons for doing so should fall into one of these three categories – primarily because they are all tangible or measurable. No instinct or emotion here. And while we are bringing cool reason to bear, we should also point out that, in the context of any reappraisal, you need to be very clear circumstances have changed materially enough to warrant selling.
If something has happened along the lines of one of the examples mentioned earlier, selling may indeed be the best course of action. If the company’s fundamentals remain robust, however, and it is more that market sentiment is affecting the business’s share price, the better option might be to ‘average down’ and buy more shares at a lower price – a process we discuss in more detail in Falling share price and On the double.
That will not be the case every time – which is when it becomes important to have the rationality, discipline and strength of mind to press the ‘sell’ button – but the overriding point is that you have in place a fundamental investment process that prevents you being caught up in the short-term emotion, hubris and noise of the day.
Juan Torres Rodriguez
Fund Manager, Equity Value
I joined Schroders in January 2017 as a member of the Global Value Investment team and manage Emerging Market Value. Prior to joining Schroders I worked for the Global Emerging Markets value and income funds at Pictet Asset Management with responsibility over different sectors, among those Consumer, Telecoms and Utilities. Before joining Pictet, I was a member of the Customs Solution Group at HOLT Credit Suisse.
Emerging Markets Fund Manager
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
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