Saturday, November 15, 2014

When Should You Sell a Good Stock?

With the market riding high again, you might be thinking about selling a few holdings and reinvesting the cash when stocks have fallen again.

Buy low, sell high. That's the idea, right?

But before you hit the sell button, consider Philip Fisher's answer to the question, "Should an investor sell a good stock in the face of a potentially bad market?" 
Even if the stock of a particular company seems at or near a temporary peak and that a sizable decline may strike in the near future, I will not sell the firm's shares provided I believe that its longer term future is sufficiently attractive... 
My belief stems from some rather fundamental considerations about the nature of the investment process. Companies with truly unusual prospects for appreciation are quite hard to find for there are not too many of them. However, for someone who understands and applies sound fundamentals, I believe that a truly outstanding company can be differentiated from a run-of-the-mill company with perhaps 90 percent precision.
It is vastly more difficult to forecast what a particular stock is going to do in the next six months...For these reasons, I believe that it is hard to be correct in forecasting the short-term movement of stocks more than 60 percent of the time no matter how diligently the skill is cultivated. This may well be too optimistic an estimate. 
So, putting it in the simplest mathematical terms, both the odds and the risk/reward considerations favor holding. 
It's a point worth re-emphasizing. You have much higher odds of identifying a truly outstanding company than guessing how that company's stock will perform in the next six months. Play the odds accordingly.

Lesson learned...hopefully

I haven't always followed this advice. In April 2006, I bought shares of Core Laboratories (CLB), a high-quality and advantaged oil & gas services company, for a split-adjusted price near $26. Two years later, with oil prices near record highs, I sold the stock near $58 and patted myself on the back for a job well done.

Don't pull out your flowers and water your weeds.
(Photo taken at Kew Gardens by my wife. Nice, huh?)
I felt particularly good about my decision during the financial crisis when oil prices plunged and Core Labs fell back around $30.

Had I capitalized on my sheer luck and bought back into Core Labs after it dipped, this story might have had a happier ending, but alas I did not.

In fact, my portfolio's subsequent returns would have been markedly better had I done nothing at all. Fast forward to today and Core Labs is trading at $139 and was up to almost $200 earlier this year.

Now, it's possible that I'm looking back at this case with a serious case of hindsight bias, but my selling decision in 2008 wasn't due to a lower opinion of Core Labs' business or its management. Instead, I wanted to lock in my 123% gain after a strong run in oil prices. Not a terrible decision, of course, but not a good one either.

To see how it's supposed to work, fund manager Chuck Akre* said in an interview earlier this year that his firm has owned shares of Markel (MKL) for over 20 years and that they didn't sell during down times. During that 20+ year timeframe, according to Akre, Markel's book value per share increased 14% annualized and its stock price has grown at least at the same rate.

If you're playing at home, those kind of annualized returns will turn a $10,000 investment into just under $140,000 over 20 years.

Bottom line

While there are some good reasons to sell a stock, trading in and out of great companies in an effort to time the stock price is not one of them. Pressing the pause button on compounding can be hazardous to your wealth.

What do you think? Let me know on Twitter @toddwenning.

Related posts:
What I've been reading/watching this week:

Stay patient, stay focused.


*I own shares of Akre Focus Fund