Knowing When to Sell

 “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” – Peter Lynch

We are almost 10 years into a bull market birthed out of The Financial Crisis, throughout which, economists have described the stock market as climbing a “wall of worry”. The market continues to rise, but no one believes that it can continue. I am confident that at some point we will experience a correction. I am also confident that, many years from now, the companies we own will be much more valuable than they are today. This assumption is based on the real products our holdings produce, their position in the market, and the leadership guiding the path. At RCG, we don’t attempt to predict the timing of market events or adjust our portfolios based on unobservable expectations. Instead, we seek to invest in the companies we believe have the best opportunity for success over the long run.

In my last post, I detailed RCG’s investment process and how we make investment decisions. In this post, I want to provide a summary of how we make our decision to exit (sell) a position.

I recently encountered a fascinating graphic detailing the many “smart-sounding” reasons to sell stocks.

Source: (@morganhousel)

A larger version of the graphic can be found here.

Each of the listed reasons is rational, but most were unpredictable and all were focused on macroeconomic events divorced from the individual investment and the ability of each company to grow, execute, and compete. At RCG, our reasons for selling are straightforward and typically fall into one of a few categories:

• Fundamental change in the business – When we see that a business has drifted too far from its roots and is no focused on the business we desired with our initial purchase. This category includes companies chasing new or illogical product lines or entering new markets in which the company may not be best equipped to compete.
• Change of faith in management – When we observe that management has lost their ability to focus and/or execute, and there is little hope for new leadership to course correct, we will consider new fishing streams.
• Valuation – When an investment greatly exceeds our assessment of fair value.
• Our original thesis changes – We invest with a clear hypothesis on why an investment is mispriced. This could be a fundamental misunderstanding by the market, or an underestimation of the opportunities ahead of the company. However, we sometimes make an investment only to later realize that our fundamental thesis was flawed. When we come to this conclusion, we exit.
• Better opportunities elsewhere – Occasionally, we continue to view an investment favorably, but we identify an opportunity that we like even more.

The goal is to hold each investment for at least two to five years, as frequent activity is the enemy of outstanding returns.   And with each investment, it is important to have a well-reasoned thesis. After all, if you don’t know why you invested, then you can’t know when it’s time to sell.