Many investors say that selling stocks is much more difficult than buying them. This certainly can be true. Much more is also written about how to figure out what is the right time to buy a certain stock. It’s just that much easier to hunt for bargain stocks and buy them than to know when the parties are over, and it would be time to sell.
How long should you hold a stock? Warren Buffett once said: “our favorite holding period is forever.” This may be true with wonderful businesses, but net-nets are rarely if ever great companies. Investors buy these stocks because they are cheap. Occasionally net-nets are valued under their intrinsic value and when they are selling clearly below their net current asset value, they should offer adequate margin of safety. This was the reason why Benjamin Graham once started to buy these stocks – and made this style of investing famous.
When selling a net-net stock is then the right move? There is definitely no one right answer. Ben Graham himself liked to buy these stocks at two-thirds (or less) of their net current asset value and sell them when they passed NCAV. When stock satyed stagnant, he held stocks for at least two years. Likewise, another legendary net-net investor Walter Schloss simply sold when the stock reached its intrinsic value, which for him was usually when the market capitalization climbed to net current assets level. This is clear and working strategy taking the emotion out of the act of selling.
However, in a 21st century global markets, it is difficult to give a single right selling rule for all stocks and markets. Many things in business can change much faster than in the 1950s and 1960s. There are many activists and small investors looking for net-nets all over the world. Corporate governance, accounting and market rules are not same everywhere. Many things that sharply increase or decrease the share price can happen much faster.
Yet the biggest mistake of many investors is to sell net-nets too early. If the stock has risen by 30-50 % in a few months, it will be a great temptation to sell it to realize a quick profit. You should remember that the net-net stock has been initially dirty cheap and when something positive comes out the upside possibility can be enormous. Don’t cut the future of three-, five- or even 10-bagger stocks too early. By doing so, long-term returns are easily modest. Often it means, that the investor does not have the nerves to implement this strategy as required. Keep in mind that the return on these winning stocks must compensate for the losses of the loser stocks – and with net-nets investors will also have losses.
With any net-net stock, you should at least hold it long enough for the research you did to be relevant. Maybe you anticipate turnaround, some activists are playing with, there’s new good management in position etc. Whatever was the reason you bought the stock, you should at least be holding it for enough time that those things can have an influence on the stock’s performance and its price. What time frame is enough? You never know. Usually it is at least one year. Often it can be two or three years – particularly if there is no visible catalyst.
As the share price rises to the NCAV level, the stock is still on average really cheap. Most of these stocks would be very cheap even when they were priced in their tangible book value. In this case you should make a new valuation and find out why the price has risen. Probably there has been a clear positive change in the company’s profitability or in the balance sheet. The net current asset value of the company may also have risen to a new level. In the best case, company’s value can multiply within a few years. These cases are not uncommon for net-net stocks.
One useful way to sell is to do it in parts. For example, one half of a holding is sold when the company reaches its NCAV level. In this way, we lock a good profit and reduce the risk of loss. But at the same time, we still retain the possibility of higher profits as the stock price may rise further. This is the preferred and effective method for most net-net stocks.
Waiting can be the most difficult, if nothing happens with the stock for a long time or it loses some of its value. However, if the basic fundamental analysis is correctly made and still remain valid, you should be patient. Remember, if I liked a stock in the first place, you should like it more if it goes down. Often, the success of these companies is based on a surprisingly unpredictable event. The company can be sold with great profit, some activist investor can come in and improve the business or the business environment of the company is undergoing a major change.
There are still some things to keep in mind when considering stock sales. When the share price changes (up or down), the investor should check whether the new price level of the company still gives a sufficient margin of safety. In addition, it is advisable to evaluate whether there has been any change in the company’s business. If a stock in its new price level still provides required margin of safety, it is frequently wise not to do anything. Smart passivity is too often the most undervalued investment activity. In many cases, therefore, the best investment decision is to do nothing. If the business instead is getting worse but the value of the stock has already risen sharply, then it may be a good time to sell immediately. It is always possible that the price of a stock still rises, but try to sell at a price peak is an impossible strategy.
The best investments are often companies, whose NCAV increases with the share price. In this case, it is possible that after a few years, the investor owns a much more valuable company, which still offers the same margin of safety as when buying. Unfortunately, these are rare cases.
There are also some situations in which a net-net stock must be sold in short order.
- If you have made a mistake in your analysis at the time of purchase
You can later find out the surprising negative things that you might not have noticed when you first analyzed the company. Likewise, a change in the business may cause that the original analysis is no longer valid. Then you need to quickly re-evaluate the situation and act accordingly.
If you notice the risk of a large loss (the chance to lose more than 50% of the invested capital), you should immediately sell the stock, regardless of how long you have owned it or how much it may be at a loss.
- If you need money for another better net-net investment
In this case, the new investment should be clearly better. Investors are easily tempted to jump from one position to another, especially if the current stock ownership feels boring. This should be strong avoided, and changes should only be made when they rationally appear to be well justified.
There are also some special cases that affect the sale of a stock. First, the stock has been acquired below its net cash value (cash and cash equivalents less all liabilities) and the company no longer has much operational business, but is basically “sitting” on its cash pile. In this case, it may be reasonable to sell a share when it reaches its net cash value because it hardly has any other business value. Similarly, if a company’s business has long been unprofitable or the business typically is hardly ever valued over its tangible book value, then selling at that price may be the most sensible solution.
Remember when selling net-nets:
* Do not sell too early or precipitately (especially if the share price has risen quickly) – prefere sell in parts
* Be prepared to hold the shares for at least 1-3 years
* Make a new analysis, if the share price has risen or dropped sharply