One of the most complex and confusing topics to try and understand in the world of investing is selling.
When to sell a stock is undoubtedly much harder than deciding when to buy. Any seasoned investor will tell you that no matter how hard you try, you will always sell at the wrong point in time (the same is true for buying).
Unfortunately, it is almost impossible to predict exactly when the perfect time to sell a stock is. You do not know what the market has in store for you over the next few weeks and months so you can only do your best and hazard a guess at the best price.
What's more, in an environment like we have today, where a multi-year bull market has pushed equity prices to all-time highs, and it looks as if the market is going to continue to push higher for many years to come, pushing that sell button is harder than ever.
Seth Klarman (Trades, Portfolio) and selling
When thinking about this topic, I always return to the writings of Seth Klarman (Trades, Portfolio), undoubtedly one of the best value investors of all time. I think some of the most invaluable information Klarman has published is from pre-dot-com bubble days.
While the rest of the market was excited and investors were rushing to buy internet-focused securities at any price, Klarman remained disciplined. His letters show this discipline clearly. In the years before the bubble burst in the early 2000s, he frequently comments about how important it is for value investors to remain focused and disciplined while the rest of the market bubbles.
Here's what he said about the discipline of selling in Baupost's June 21, 1996, letter to investors:
"We will not stray from our rigid value investment discipline. We buy absolute bargains when they become available, and sell when they are no longer bargains. We hold cash when there is nothing better to do, and we hedge against the risk of a dramatic and sustained downturn in the market. Our hedging over the last several years has been expensive and, with perfect hindsight, unnecessary. Yet we are convinced that hedging against catastrophe has been the right thing to do, and it thus remains an integral part of our overall investment posture."
To say that it is best to sell a stock when it is no longer a bargain might seem like an obvious statement to make, but you need to ask yourself, when do you know that the company you own is no longer a bargain?
There is no easy answer to this question. It requires work, time and effort to establish how much a company is worth, and if it is over/undervalued. This is a continual process. A value is required on entry, but it also needs to be updated as time goes on. A company is not a fixed income security; it is a dynamic entity that is always growing, changing and evolving. Your valuation of the business and estimate of fair value should do the same.
It is not easy
Continually evaluating a company and its prospects and intrinsic value is not easy, but because so few other investors are willing to follow the same path, it gives those investors who are willing to put in the extra work the edge.
It is this edge that helps value investors beat the market over the long term, as Klarman went on to explain in his December 1997 letter to investors:
"In a bull market, anyone, with any investment strategy or none at all, can do well, often better than value investors. It is only in a bear market that the value investing discipline becomes especially important because value investing, virtually alone among strategies, gives you exposure to the upside with limited downside risk. In a stormy market, the value investing discipline becomes crucial, because it helps you find your bearings when reassuring landmarks are no longer visible. In a market downturn, momentum investors cannot find momentum, growth investors worry about a slowdown, and technical analysts don't like their charts. But the value investing discipline tells you exactly what to analyze, price versus value, and then what to do, buy at a considerable discount and sell near full value. And, because you cannot tell what the market is going to do, a value investment discipline is important because it is the only approach that produces consistently good investment results over a complete market cycle.”
Disclosure: The author owns no share mentioned.
