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Thorough analysis of performance of selling decisions


Lupo Lupus
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Just did a thorough analysis of my sold positions.

 

Many investors have the feeling that their selling decisions are poor as the price tends go up further. However, the latter by itself is not surprising, in particular in a bull run.

 

One should thus compare the performance of sold positions with a benchmark, or better, with the performance of the remaining performance (the thinking goes that I could scale up my existing portfolio, hence this is my ultimate private yardstick).

 

The results for me were very surprising. While my sold positions went up about 10% annualized, they underperformed my portfolio by 9% annualized!!

 

So a large part of my (personal) overall outperformance seems to come from selling decisions.

 

I am still contemplating the implications of this. Lets put this to an extreme. Suppose my outperformance were to come *entirely* come from selling decisions. That is, the stocks I buy on average do not outperform. However, they sometimes jump above fair value (after having bought them) in which case I sell them. Following this they underperform as they return to fair value.

 

What does this imply for stock selection? Even though in this case I am not able to select outperforming stocks, stock selection is not meaningless as I should concentrate on stocks that are more likely to deviate positively from intrinsice value *after* I bought (so I sell them for a quick gain). Thus looking for stocks with a higher likelihood of ex-post price inefficiency (as opposed to a misvaluation at the time of purchase).

 

Has anybody been thinking among similar lines?

 

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Lopo, over the years I have tried to modify my sell strategy. I found that I was pretty good with the buy decision: buying well run companies when they were out of favour (due to company specific or industry issues). Sometimes they would run up 10, 20 or even 30% shortly after purchase and I would be happy to sell and book some nice decent sized profits; often the fundamentals were also improving. Sometimes the stock I sold would keep on going, rising 100 or 150% over a couple of years as the fundamentals were improving and/or the market fell back in love with it and gave it a higher PE ratio.

 

I like Peter Lynch's advice that you sell when the 'story' changes for the worse (not because you can book a quick profit). I tend to run a fairly concentrated portfolio; this is because I can only find a few stocks (or industries) that i really like and find cheap enough to invest in; selling my few good ideas early meant I was sitting in cash lots (earning nothing).

 

The change I have been making (starting with my Apple purchase 4 or so years ago) is if fundamentals are improving to not focus so much on my immediate % gain and instead let the story play out; as long as fundamentals are improving be patient and let the stock run higher. Time will tell if this is the right approach.

 

I have not done a detailed my sell decisions like you have. :-)

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Racemize, I did a quick internet search; here is a quote from investopedia that helps:

 

"Lynch coined the term "tenbagger" to describe a stock that goes up in value ten-fold, or 1000%. These are the stocks that he was looking for when running the Magellan fund. Rule No.1 to finding a tenbagger is not selling the stock when it has gone up 40% or even 100%. Many fund managers these days look to trim or sell their winning stocks while adding to their losing positions. Peter Lynch felt that this amounted to "pulling the flowers and watering the weeds"."

 

Read more: Pick Stocks Like Peter Lynch http://www.investopedia.com/articles/stocks/06/peterlynch.asp#ixzz4lifZFstp

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Racemize, I did a quick internet search; here is a quote from investopedia that helps:

 

"Lynch coined the term "tenbagger" to describe a stock that goes up in value ten-fold, or 1000%. These are the stocks that he was looking for when running the Magellan fund. Rule No.1 to finding a tenbagger is not selling the stock when it has gone up 40% or even 100%. Many fund managers these days look to trim or sell their winning stocks while adding to their losing positions. Peter Lynch felt that this amounted to "pulling the flowers and watering the weeds"."

 

Read more: Pick Stocks Like Peter Lynch http://www.investopedia.com/articles/stocks/06/peterlynch.asp#ixzz4lifZFstp

 

Right, I remember the watering the weeds one--I just didn't remember one about waiting until the story changed.  Is that your paraphrasing?  It seems like a decent thought.

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Racemize, I do not have my copy of 'One Up on Wall Street' handy buy my guess is I got it from there.

 

Here is a second quote from the Investopedia article:

 

"Lynch has said that "absent a lot of surprises, stocks are relatively predictable over 10-20 years. As to whether they're going to be higher or lower in two or three years, you might as well flip a coin to decide." It may seem surprising to hear such words from a Wall Street legend, but it serves to highlight how fully he believed in his philosophies. He kept up his knowledge of the companies he owned, and as long as the story hadn't changed, he didn't sell. Lynch did not try to market time or predict the direction of the overall economy."

 

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The hard part about "sell when the story changes" is that the "story changes" part is usually only obvious after the fact and you may have lost quite a bit by the time it becomes certain. Or you may jump on every "story change" before it's confirmed and get whipsawed. E.g. did story change for AAPL in 2012? In 2015? Now we seem to know that it did not, but I've heard different opinions at the time (look up the thread if you want).

 

Did story change for IBM? (I guess even Buffett now says it did). How about NKE now? How about CVS?

 

I don't expect these questions to be answered here, but IMO the principle is not so easy follow.

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Racemize, I do not have my copy of 'One Up on Wall Street' handy buy my guess is I got it from there.

 

I have both the book and pdf, so the search is easy.  8)

From Chapter 4

“The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as long as the fundamental story of the company hasn’t changed.”
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I have both the book and pdf, so the search is easy.  8)

From Chapter 4

“The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as long as the fundamental story of the company hasn’t changed.”

 

+1

Being relatively new to individual security investing (2 years), I've built this line into my checklist as to the expectation of the story and what to watch out for that will change the thesis significantly.

 

Another selling issue that came up for me running a concentrated portfolio (focused on biotech mostly micro cap and small cap, apart from one other investment) is how to handle successes when they conflict with asset allocation. I read in Beating the Street even when Lynch "backed up the truck" for Fannie Mae it was at a limit of 5% of portfolio set by Fidelity. For my tax deferred IRA I've made a rule to sell if asset allocation to an individual security exceeds 25% of total portfolio. This was very hard to follow when the story did not worsen but actually changed for the better on a company whose market capt went up more than 6 fold in 6 months (Achaogen). Curious how others with concentrated portfolios handle this part of selling versus asset allocation.

 

I think in the end it is the original point made, judging what kind of return did the reinvested capital make on alternative investments in the long run, that matters. 

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