A client asked whether there is a difference in our sell discipline between high- and low-growth companies.
Selling is one of the hardest parts of investing. I wrote a lot on the subject in the past, but let's zoom in on how our selling practice differs between high-growth companies with long runways for compounding and slow-growth companies.
Let's take McKesson (MCK, Financial), for example, MCK grows revenues 3%, maybe even 5%, a year (depending on drug price inflation). Its earnings growth will be helped by MCK buying back its stock. This will add another 3–8%, depending on the valuation of the stock (the cheaper the stock the more shares it can buy). When we look at McKesson's earnings four years out, we have a relatively narrow range of fair values for the company. As the stock starts approaching our middle-of-the-road fair value, we'll start decreasing our position. As it gets to the higher end of fair value, we'll sell the full position. The difference between the low and high fair values for these two scenarios will probably be 15–25% or so. MCK is a very stable and predictable business. We may sell it in halves, thirds, or quarters. This is not a science but an art.
Then we'll have companies that are run by owner-operators that have a high return on capital and a long growth runway. Let's call them perennial compounders. With these types of companies we need to be more patient with our sell discipline than with McKesson. This combination of owner-operator (especially when he/she has skin in the game), high return on capital, and opportunities to reinvest this capital often surprises us with an upside scenario. We are a lot more patient (and forgiving) with this type of company.
We keep companies like McKesson on a relatively short leash. For companies like the perennial compounders we need to use a longer leash, one of those extendable leashes.
And one more thing…
I am not a journalist or reporter; I am an investor who thinks through writing. This and other investment articles are just my thinking at the point they were written. However, investment research is not static, it is fluid. New information comes our way and we continue to do research, which may lead us to tweak and modify assumptions and thus to change our minds.
We are long-term investors and often hold stocks for years, but as luck may or may not have it, by the time you read this article we may have already sold the stock. I may or may not write about this company ever again. Think of this and other articles as learning and thinking frameworks. But they are not investment recommendations. The bottom line is this. If this article piques your interest in the company I've mentioned, great. This should be the beginning, not the end, of your research.
Vitaliy Katsenelson, CFA
Student of Life
I am the CEO at IMA, which is anything but your average investment firm. (Why? Get our company brochure in your inbox here, or simply visit our website.)
In a brief moment of senility, Forbes magazine called me the new Benjamin Graham.
Ive written two books on investing, which were published by John Wiley & Sons and have been translated into eight languages. (Im working on a third - you can read a chapter from it, titled The 6 Commandments of Value Investing here.)
And if you prefer listening, audio versions of my articles are published weekly at investor.fm.
