Victory For Gold
March 20, 2010
Why Invest In Smaller Companies?
March 21, 2010

When To Sell?

Selling is always the hardest part of investing. If you get the investment wrong, you should sell. It’s simple. Your only real decision is if you sell right away because things are about to collapse or if you should wait for better prices. This is on a case by case basis.

A lot of the time, you just get tired of holding an investment. I’ve had many of these. You had a thesis, and it hasn’t played out like you expected. At the same time, you like management, you like the business, you like the assets and things are going in the right direction—however there just isn’t the right momentum behind things. Do you sell? I usually do. I like to give an investment a few years. Nothing ever happens overnight. If your thesis isn’t playing out after three years, move on.

The hardest sell decisions are when you get it right—very right.  These are the situations when a stock is up 3 or 5-fold from where you bought it. You have huge profits. What do you do? There’s nothing wrong with taking profits. However, in the decade that I’ve done this, I have almost always come to regret selling a stock that is doing well. If you bought my winners from me—only my winners the day I sold them—you’d be a very rich guy. I always sell good companies too soon.

When you are dealing with smaller companies, you need to throw conventional valuation metrics out the window. Rapidly growing companies always look expensive based on current earnings. They look expensive based on next year’s earnings. They simply look expensive. You have to ask yourself: is the valuation is justified? Often it is. Think of it this way. A company at 25 times earnings isn’t that expensive if it is growing 50% a year. Can that growth rate be sustained? If it can, you will make 50% a year if the multiple stays constant. That’s a healthy rate of return.

Smart management teams can use their shares intelligently. They can issue more stock to pay down debt or cover working capital. They can make acquisitions. If you buy a competitor that’s at 10 times earnings, it’s accretive—even before synergies and cost savings. Just because the shares are expensive—that doesn’t mean you have to sell. Often, you shouldn’t sell.

So when DO you sell? I sell when management sells. If I see sizable insider selling, I’m out. Insiders always know what’s going on. Maybe business isn’t doing so well any more. Maybe a new competitor just showed up. Maybe they feel like they’ve made enough money and they want to cash out. Hopefully, they sell the whole company. That way the sale decision is easy for you.

I sell when it is obvious that the business is changing; an acquisition that doesn’t make sense, a change in business strategy or a change in how they approach the business. I sell when something is obviously going to happen to the business. Usually this is a change in a regulatory structure or a new competitor.

I sell when the valuation has gotten simply goofy. This is subjective. 25 times this year’s earnings isn’t expensive if the business can grow for a long time. 50 times expected earnings looking out five years just makes no sense. Almost every time I’ve sold because the valuation got stretched, I regretted it within a year as the stock doubled again—and again.

I sell when something just doesn’t feel right—even if I cannot put my finger on it. You have to use your intuition.

I NEVER sell just because I am not optimistic about the economy. If my company is good, they’ll come through just fine. I don’t sell if the chart looks bad—I’m a long term investor. I don’t sell if my company gets downgraded by some analyst.  I really try not to sell. If I like how things are going, I try to own good businesses forever. It takes a long time to learn about a business. It takes forever to get to know and appreciate management. If you sell, you have to pay taxes. I try to find things I can own for years. When you do sell, it should be really obvious that a sale makes sense. If not. Be patient and enjoy your profits.

Categories: Investment Strategy
Positions Mentioned: none

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