It is almost assured that at this point, given the strong equity market returns seen over the last few years, many investors will undoubtedly have a series of internal debates over when to sell.
It would seem it is almost unarguable to suggest market valuations in general are high. Whether one wants to debate relative values relating to interest rate levels or the general multiples of markets, it is very difficult, at least in my opinion, to suggest that absolute valuation levels for certain securities and entire markets are cheap.
Knowing this, should one sell? The snap response would of course be yes — at least for the more ardent valuation constrained investor, but this seems to miss a more nuanced consideration. Consider for example two distinct questions: If you sell when do you rebuy? If you sell what do you buy or own in exchange?
In the case of the two questions posed, I am strictly referring to individual securities and not “markets” or general asset allocations where one would naturally rebalance to underperforming assets as a part of a prudent asset allocation policy. What follows should not be construed as personal financial advice but just some aspects to consider when discussing with your financial adviser.
It is very hard if not impossible to time markets. Maybe the hardest part is that you need to make two decisions: when to get out and when to get back in. This essentially means you need to overcome a series of psychological biases and be right twice. Not exactly an easy task.
If one is invested in stocks to steadily build and preserve wealth over a long period of time then the strategy should not include trying to jump in and out of the market based on short-term concerns, or performance. By attempting to be out in down periods many investors actually miss periods of exceptional returns and incur trading costs and market impact costs. Plus by timing markets you are giving up on compounding wealth over certain periods while you remain in cash or cash equivalents. It really is time in the market not timing the market that counts.
Instead of trying to time the market, we would suggest focusing on the value our individual positions (valuation timing if you prefer). By knowing which companies you own and what we think their fundamental values are, we essentially stick to buying companies that are undervalued and selling those that are fully valued and avoid those that are overvalued.
Market timers use cash as a function of what they think the market will do. Our cash and short-term bond book are part of the client’s risk management and asset allocation decision. They are also a by-product of our investment opportunity set. If we cannot find anything undervalued in our universe of thousands of companies we will default to a slightly higher cash position. Overall market dynamics may seem cheap or expensive but our process will always be driven mainly from the bottom up analysis of individual securities which we feel offer compelling long-term value. It is very unlikely that there will be nothing to buy or own.
Another point to consider. Any investor who has been in the game for some time can likely attest to the difficulty in finding truly great companies. With literally thousands of companies to look at finding the great ones can be daunting. When you do find a great company it often is what is referred to as a compounder — a company that is very likely to be worth a lot more years from now due to its ability to reinvest profits at high rates of return for years to come. In this case, selling could come at a very high opportunity cost. Let Warren Buffett offer some wisdom here: “The question about selling a really great business is never. Because to sell off something that is a really wonderful business because the price looks a little high or something like that is almost always a mistake. It took me a lot of time to learn that. I haven’t fully learnt it yet. It’s rare it makes sense. If you believe the long-term economics of the business are terrific, it’s rarely makes any sense to sell it.”
Need an example? Let’s take one from Berkshire Hathaway’s 1995 annual report: “I first became interested in Disney in 1966, when its market valuation was less than $90 million, even though the company had earned around $21 million pre-tax in 1965 and was sitting with more cash than debt. At Disneyland, the $17 million Pirates of the Caribbean ride would soon open. Imagine my excitement — a company selling at only five times rides!
“Duly impressed, Buffett Partnership Ltd bought a significant amount of Disney stock at a split-adjusted price of 31 cents per share. That decision may appear brilliant, given that the stock now sells for $66. But your chairman was up to the task of nullifying it: In 1967 I sold out at 48 cents per share.”
What has often struck me as odd is that investors will be quick to unload stocks when markets turn or the economy weakens but most business owners would, more than likely, not even consider a sale of a company he/she owns that has superb economics.
So if timing the market is impossible and you question whether it is ever a good time to sell a great business what can you do? What are a few things to consider to ensure you stay in the game and let compounding work? Here are a few to consider:
1. Always hold a cash reserve. Cash offers optionality and comfort. Portfolios should always have some cash on hand to take advantage of opportunities when they arise and offer a ballast in the storm.
2. Use money you do not need for years. Investing is a long game. Trading is the short game. If you are really investing, the assets involved should not be encumbered in any way and should truly be committed for years. I would suggest three years at a minimum and the longer the better.
3. Stick to quality. Quality companies come back and can survive most dislocations. A big risk is actually purchasing low-quality business at higher valuations during times of positive business conditions.
Berkshire Hathaway Inc 1995 Annual Letter http://www.berkshirehathaway.com/letters/1995.html
Nathan Kowalski CPA, CA, CFA, CIM is the Chief Financial Officer of Anchor Investment Management Ltd. and the views expressed are his own. Disclaimer: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by the author to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their financial advisers prior to any investment decision. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.