Being a successful investor requires a plan -- a plan on when or how to enter a position, a plan on how to conduct analysis on a company and a plan on when to sell a stock. The first two plans are very easy to compile compared to the plan of when to sell. Deciding when to sell is, in my view, one of the most difficult parts of investing because it requires a huge amount of guesswork and there is a 99.99% chance that you will get it wrong.
As far as I can tell, there are only two investors in the world who have come up with a solution to this problem all investors will encounter at some point: Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio).
The approach both of these billionaires have taken is one that eliminates the question of when to sell all together. To begin with, they are only looking for businesses that they can buy and hold forever. They know they are not clever enough to try and predict the future, or calculate estimates of intrinsic value, so they don't bother.
Here's Warren Buffett (Trades, Portfolio) talking about this approach in a lecture in 1991:
"Question: When you look at a company, how do you value it, how do you decide how much to pay for it, and after that, would you say how much you’d sell it for.
Well, we won’t sell it. We just don’t sell businesses. If we had a business that would permanently lose money, or we had a manager lie to us, or cheat us, or...But we will never sell a business just because we get a wonderful offer for it. My house isn’t for sale. The children aren’t for sale. The businesses aren’t for sale. I tell shareholders that. That may make me crazy, but that’s who they’re getting in with, and they might as well know it. It is not a game we’re playing, like gin rummy, where we pick up one card and discard another."
The key to this approach, Buffett goes on to say, is to only invest with managers with whom he has a good business relationship. If there is a good relationship between the two parties, and the company's manager has already achieved fantastic results, selling just because you want to realize the gain does not make sense. It is better to let the money sit and compound.
"And I think good human relationships... I work with nothing but people I like. There’s not one person I work with that causes my stomach to churn in the least. In fact, I feel like tap dancing. I work with nothing but people I like. Well, just think how fortunate you are if you’re 60 years of age and that’s the way you’re going to be able to spend your life. These people are wonderful to work with. I mean, Ike Friedman...we never disagree. Charlie Munger (Trades, Portfolio), my partner, and I have never had a disagreement in 30 years. And, why in the world [would I sell businesses run by people I like] so that I can be worth 110% of X, instead of X, when I die? It will all be in the foundation anyway. Why should I go around discarding people like that who are in the business, for some people who might not turn out so well? So I’m not interested in selling at all."
And how do you decide when to buy? Simple: Invert the selling criteria:
"Now, in terms of buying, a) I’ve got to like the people. I’m just not interested in marrying for money. That might have been great when I was 12, but it would be crazy now for me to marry someone for money. Why should I marry in business for money? It just doesn’t make sense. I get associated with these people, so I want to buy the people I like, and I want to buy businesses I understand, and then I don’t want to think too much. And, paying too much simply comes out."
Disclosure: The author owns no stock mentioned.
