To use another
analogy: sales on the part of many investors are akin to someone
hurtling off a ski jump without any training or advance preparation.
The results are usually catastrophic.
To continue with
this analogy: successful jumps are the result of a tremendous amount
of advance preparation: physical conditioning, technical training,
and the cultivation of a suitable mindset.
So it is with
investing. I have prepared a simplified approach which outlines the
process I follow in deciding when to sell. As you can see, the
decision to sell has its origins very early on in the investment
process. It is taken in consideration of a wide variety of factors –
the least of which is often the daily/weekly/monthly up's and down's
of the price charts.
Pre-Purchase Stage
Some considerations:
- portfolio allocation model
- strategic outlook for sector
- risk management strategy
- company fundamentals
- intuition - sense of the market
- statement of reasons for purchase
Purchase
Some considerations:
- timing
- price
- exit strategy
Monitoring
Some considerations:
- company fundamentals
- competition
- market conditions
- price?
Sale
Some considerations:
- review of exit strategy/reasons for purchase
- price
- timing
Follow-up
Some considerations:
- post-mortem - lessons learned
- continue to monitor company
Pre-Purchase Stage
The model identifies several considerations which I investigate before making a
decision to purchase. Through the screening process, I develop a
rationale for establishing a position. Since there are many
different styles of investing, the considerations will differ from
investor to investor. I tend to follow a value approach and have
developed a screener and decision process which is suitable to my
personality. I wrote about it in an earlier edition of The
Financial Passage Maker. The table which describes my screening methodology will be appended as part of the next quarterly e-mail version of The Financial Passage Maker.
The important
outcome of this step is to write down your rationale and to identify
some key variables which you will monitor.
You will see “risk
management strategy” as an element of the pre-purchase decision.
Unlike professional investors (who have to appear to be more
scientific and professional) I do not use sophisticated models and
metrics. Instead, I tailor the amount of my initial stake according
to my sense of the risk involved:
- competitive positioning
- financial health of the enterprise
- quality of management
- quality of the business model (simple/understandable is best)
- track record/stage of development (e.g. I will invest less in new upstarts as compared to more stable entities with a strong competitive position and robust financials)
Taking this approach to risk management
has saved my bacon on many occasions in the face of rather
spectacular losses on some of my more speculative ventures with small
companies.
Purchase
It is tempting to
try and time the market. Few investors have a consistent track
record in this regard and many are the high flyers who have crashed
and burned on the expectation of their invincibility. I never try to
time the market unless I sense that the sector is about to be
out of favour. In such instances, I wait for what Herr Buffet calls
“the fat pitch” - when valuations and the strategic positioning
are very compelling. This period of waiting can take months/years.
For this purpose, I have established a “watch list”. I monitor
it to get a sense of the sector and the market and establish a
position when I feel comfortable.
I never enter a
market order (pay the prevailing market rate) when I purchase a
security. Instead, I specify a firm purchase price, thereby
minimizing surprises on the up or downside.
At the time of
purchase, I also set out an exit strategy. It hardly ever involves a
price point ... except when I am engaged in short-term speculation.
Monitoring
The criteria for
purchasing a stock form the basis of my monitoring strategy. As
such, the items I monitor will vary from stock to stock. I try to
keep things simple and focus on the basics. I have learned not pay
much attention to the price action as a focus on short-term variation
tends to obscure the long-term fundamentals which drive valuations.
I NEVER pay much attention to talking heads on TV and/or commentators
who rarely own the stocks. I have learned to disregard some writers
who are nothing more than paid shills for companies. On occasion, I
do look at annual/quarterly reports from some money management firms
to test my reasoning.
Sale
If I detect a
fundamental change in the conditions which led me to establish my
position, I will generally sell (or at least, reduce my holdings if
things are a bit unclear). I always sell at a fixed price point as opposed to an open sale price. Further, I
never try to squeeze out the last penny as fast-moving prices can
leave you without a sale.
Institutional
investors tend to get a bit “fancy” with purchase and sale
strategies, but as a small investor, I simply do not have the resources to compete with them on this basis. Instead, I prefer to compete with them on the basis of
greater agility, and my ability to wait out hard times (client
pressure and the need to boost quarterly earnings are major
impediments to performance on the part of institutional investors).
Follow-up
Like reheated pasta, some stocks are better the second time around. Short of encountering an element of fraud (common with some of the Canadian listed stocks with Chinese-based operations I have owned in the past), I usually monitor stocks which I have sold off. It may be that the sector is out of favour or that a company has suffered set-backs of consequence. With the thought that companies may overcome set-backs, I maintain a watch list of former members of my portfolios.
When selling a stock, I also write down reasons for success/failure and use them as a reference. Here are a few findings:
- an uncritical acceptance of buy recommendations from ANYONE has usually led to losses (I have learned to eat my own cooking.)
- it is best to restrict investments in smaller, less stable entities as they are generally more volatile than their larger cousins
- my best investments have resulted from identifying promising economic sectors and then selecting the best of breed for profits
- the power of dividends provides some recompense for waiting for the value of some stocks to be recognized by the market (this can sometimes take years)
- by the same token, dividends can reduce the pain of loss
- "concept" stocks are generally more speculative and I have learned to get out after earning profits in the range of 50 percent e.g. rare earth miners, battery makers (holding on with the hope that profits will be greater is tempting but not profitable as a general rule)
- the value approach has produced the bulk of my core holdings - stocks which have been friends for many years.
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This model is offered as "food for thought". It represents a thought process as opposed to a recipe. You can tailor it to meet your approach to investing and your personality.
The main point is that the decision to sell is not an isolated event. You should build the basis for that decision from the moment of screening potential purchases. That way, you will be more able to avoid the temptation to sell when others are rushing for the exits, by either selling before the herd stampedes or by waiting out temporary set-backs for sunnier days.
I have found that the model has a calming effect: that it has allowed me to not get "spooked" by short-term gyrations which may be produced by failures to meet analysts' quarterly earnings expectations (a silly pre-occupation) or temporary set-backs which are normal for any dynamic business.
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