“Our Favorite Holding Period is Forever” Warren Buffett

I love this quote from Buffett – it represents a philosophy that’s a world apart from the frenetic behavior of Wall Street. But many people confuse the meaning behind it. They get upset when they see Buffett selling down, claiming he’s not following his own advice. This is to misinterpret his meaning. When you buy as stock, you should indeed view it as becoming a part owner in a business. You bought it because you believe in its long-term prospects, you got a great price for it and you hope to benefit from your purchase for many years to come. But this doesn’t mean you won’t ever sell it under any circumstances.

Trading Versus Investing

As I explained in my post last week, a successful investor needs to understand that investing and trading are two separate philosophies.. The “stop-loss” is one dangerous concept that investors seem to borrow from the world of trading. But to sell on a stop-loss is to be directed by the price action alone, with no reference to the underlying value of the stock. It goes against everything that an intelligent investor should stand for

“would you sell your house to whatever bidder was available at 9:31 on some morning merely because at 9:30 a similar house sold for less than it would have bought on the previous day?” Warren Buffett

So when should you sell a stock? An intelligent investor sells because the price no longer represents an attractive discount to the underlying value. This can happen in one of two ways

  1. The price approaches, or rises above, intrinsic value
  2. The intrinsic value declines because of a change in the fundamentals.

This still gives plenty of flexibility to adopt your own personal approach. Buffett admits himself that he errs on the side of inactivity, holding great stocks even after they become expensive. Seth Klarman on the other hand likes to sell stocks before they get to a fair value and reinvest the proceeds into new opportunities. Regardless of which model you follow, you need to have a clear strategy for selling stocks that references the intrinsic value.

Taking the Emotion Out

As always, emotion is the worst enemy of the investor. There are two key reasons why investors make suboptimal decisions when it comes to selling:

  1. They become emotionally invested in the business and refuse to sell it under any circumstances
  2. They have made a loss on their original investment. Aversion to crystalizing that loss causes them to hold on to an investment even where there is little or no upside.

The toughest decision for many investors is selling a company where the fundamentals have deteriorated, thus requiring a re-evaluation of the investment case. The right decision here often involves crystalizing a loss. This is not an uncommon situation, and intelligent investors recognize the need to make these decisions from time to time (after all nobody can accurately predict the future). If you face this kind of decision force yourself to take emotion out of the equation and remember – successful investors are in the business of making money, not in the business of always being right.

The Opportunity Cost

There is another factor that should influence your decision – the opportunity to reinvest your proceeds into other stocks with more upside. This is one of the reasons why Seth Klarman often sells down his holding when the price is 10% off intrinsic value – in order to invest in a stock that is 50% off intrinsic value. The existence or otherwise of these opportunities will affect your propensity to sell existing holdings.

“Decisions to sell, like decisions to buy, must be based upon underlying business value. Exactly when to sell or buy depends on the alternative opportunities that are available” Seth Klarman

By their nature these “fat pitches” are rare, which is why Klarman’s funds appear so inactive most of the time.

Developing a Process

Most investors intuitively understand the need to have a clear process for buying stocks. But to be a great investor you also need to have a process for selling stocks – this requires constant monitoring of what you have in your portfolio and weighing those stocks up against potential new opportunities. This won’t always result in a sell and buy decision – in fact those decisions should be rare. But when you do make that decision, you can be sure it’s the result of a thorough process, not just a panicked reaction resulting from a temporary price move.

Tom Beevers is the CEO of StockViews.com, an equity research platform

Join the conversation! 4 Comments

  1. One thing to remember is to be realistic, not get greedy and expect a fair return on your investments(Graham’s rule-well practiced by Buffett I think).This means expecting 6-12% return, not 20-30% which everyone dreams about!

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    • Thanks for the comment! This makes a lot of sense – my opinion is that one should invest with a large “margin of safety” in anticipation of a fair return. Because of uncertainly in any calculation of intrinsic value, an investor is unlikely to see the gap close entirely – but getting part way there will provide a good return, while your downside is protected.

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  2. Hello,

    I have so much to think about your post, so first of all thank you, because it happened to enlightened things I hadn’t realize about investing. Such things as selling when the underlying value goes down, reaching then the actual price of the stock wasn’t clearly a situation to consider when investing. This really emphasizes the important to consistently monitor your stock as your game can change. A reminder!

    Speaking of plan, I like the book written by Monish Pabrai (The Dhando Investor) that makes it a clear step when investing to have a plan. When to get in, when to out, and most of all to know why for every single decision, and stick to it. This actually helps to get away from emotions that can so easily take up on us, simple humans. Such tools as planning are supposed to help prevent this kind of behavior.

    Here’s a quick question: “How do you prevent yourself from being overwhelmed by emotions directed by the Market?” I use mostly checklists.

    Thanks again Tom,

    I.V.MOATS
    ivmoats.wordpress.com

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    • Thanks for your comment and glad to hear you found this post useful. As you say, constantly monitoring the stocks that you do own is important – which is why it often doesn’t pay to get too diversified. How not to get overwhelmed by emotions? You need to ensure you are process driven – that you buy and sell stocks as a result of a robust process (checklists can help in this regard), not just because you don’t like the stock anymore. Educating yourself about emotional biases is also valuable – the investor who can recognize such a bias in themselves is much better armed against that bias

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