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Question for Parsad


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Guest Bronco

I feel beaten today - so keep that in mind.  I'll concede Vancouver is the best team in hockey right now.  The playoffs - well, anything can happen.

 

My Flyers have been struggling lately, but I am hopeful they turn it on.  I still think the Flyers are the deepest and best team regarding position players - but I would trade goalies with you any day of the week.

 

Stocks - I think we all know your philosophy and you stick to your value investing.  Others can comment as well (that is the hope), but we don't talk about selling decisions too often on this board.  What is your criteria?  Do you sell when you see better opportunities and that is your primary guideline?  Do you sell when an investment reaches 20% or more of your estimated IV? 

 

Just curious - again, others chime in, unless they want to rip on the Flyers or talk about share buybacks or increasing corporate tax rates.

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Meaty food for thought.

 

We generally sell if we realize we've made a mistake as new information appears.  We also sell when there is the prospect of a material drag or impairment of a company or industry or when there is a bubble about to pop.  We will sell in generally good conditions when something better comes along, but not if it's a close call.  That would create unnecessary frictional costs, exacerbated by biases such as thinking that the grass is always greener on the other side of the fence.

 

We're always ready to sell quickly in special situations that are not candidates for becoming long term holdings.  These trades are often made in accounts that are not subject to significant capital gains taxes.

 

Great businesses with long term capital gains would be the last to be sold, especially for a price less than IV.  We would not expect to do this unless funds were needed for a compelling reason, such as picking up extradinory bargains as happened in March, 2009.

 

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I stole this from Bill Miller or Monish Pabrai. Perhaps both.

Nowadays I sell generally  because I have found a better options (typically cash).

 

 

3 Reasons for Selling

 

1) The investment has reached its intrinsic value.

2) You have found a better investment opportunity.

3) Your original reason / thesis for the investment is no longer true or valid.

 

Caveat on #3 - You have to be convinced that the situation has deteriorated and that there is a substantial risk of a permanent  loss of capital. If the situation is unclear and the position is at a lose then the investment should be held until a clearer picture emerges or for a minimum of 2-3 years.

 

 

 

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I certainly agree with Myth on reasons two and three, but not quite on reason one.  Below are my thoughts on selling from our January 2011 letter:

 

Over the years we have seen many a portfolio manager holding (and often touting) a stock that is near to their price target. We think this is a huge mistake that prevents many managers from outperforming the market.  Let me give you an example.   

 

In our October (2010) month end letter we profiled Calamos Holdings.  At the time the stock was under $12 per share and we estimated fair value to be $17.35 per share based on a multiple of earnings of 13, plus adding back cash and the net present value of its tax deferred assets.  Since then, Calamos’ assets under management have continued to rise and thus our estimate of fair value is around $19 per share.  The stock currently trades at just over $17 per share. 

 

Has Calamos hit our price target of fair value?  No.  Have we started selling some shares? Yes.  The reason why is that the risk/reward relationship has changed as the price rose.  Obviously, there is now less upside to be gained.  When we purchased we paid 50 to 70% of our estimate of fair value, meaning we had potential returns of 42 to 100% if Calamos reached fair value.  With a current price of $17 and fair value of $19, we only have a potential return of 12% to reach fair value.

 

In addition, if we had continued to hold all of our shares, what started out as a 5% position, with 42 to 100% upside potential, would have risen to a 7% position, with only 12% upside potential.  We have no interest in having 7% of the fund be invested in a security with so little upside compared to other opportunities available.  (I would note that management of Calamos made recent statements about their desire to create a greater degree of clarity regarding the company’s market capitalization, which is positive for the stock, and means that our $19 fair value estimate could be too conservative.)       

 

In other words, our quote in our one-page update about holding until fair value is reached, is generally true but should be read as having the qualification that we will begin to trim a position as it approaches our price target due to the price increase changing the risk/reward relationship.  At times a position will be sold before it reaches our price target if a more attractive opportunity presents itself.  We think this approach allows us to capture the “easier” returns and helps the fund be more conservatively positioned by owning stocks that are trading at a meaningful discount to our estimate of their intrinsic value.

 

 

Tim

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According to "There's Always Something to Do" about Peter Cundill, which I recommend to people (as others have), Peter Cundill struggled with the sell strategy for quite a while in managing funds.  He finally settled on a rule that the fund would sell half of a position whenever it doubled, essentially leaving the remaining half at the discretion of the fund manager / main proponent of the investment.  In this way, they took the easy and quickest money off the table, increased cash position for next round and left discretion in the manager's hands to let the winner run if they thought it worth the continued risk. 

 

This is similar to something I believe Longleaf does, which they referred to in a recent annual report as "the quaint old school idea of selling half the position to take some chips off the table" or something similar.  I think that was Longleaf.  Perhaps Southeastern.

 

There would be exceptions -- the truly forever type buy and holds perhaps.  Also, might depend on the approach. Cundill was running a deep value approach fund, so he was not investing in the high ROE compounding machines.  Also probably depends on whether funds are held in tax-advantaged accounts vs. taxable to a high degree.  I've taken to using this approach for the underpriced but mediocre businesses, and using my Roth or regular IRA for those, while using a taxable account for the truly long, long term buy and hold compounders. 

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Guest Bronco

Personally, I look at my track record and selling is a bigger area I could improve upon than buying. 

 

What I am hearing so far is different reasoning for selling in different scenarios.  Sell because there is better opportunity.  Sell because it meets IV.  Sell because the reason you bought it has changed.

 

In seems that the ordering of these reasons would be:

 

1.  Sell when reason you bought it has changed - either due to external conditions (economy, earthquake, specific product, etc.)

 

2.  Sell because the stock is either above intrinsic value or around IV, depending on the person

 

3.  Sell b/c you need funds for another investment.

 

I am not saying what is right or wrong here but many times I throw ideas out to generate new conversations. 

 

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That would create unnecessary frictional costs, exacerbated by biases such as thinking that the grass is always greener on the other side of the fence.

I think emotional attachment might be a way bigger bias for me. Finding something else that I am as sure about as my present holdings is enormously hard.

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3 Reasons for Selling

 

        1) The investment has reached its intrinsic value.

        2) You have found a better investment opportunity.

        3) Your original reason / thesis for the investment is no longer true or valid.

 

Hi Bronco,

 

Mohnish's three reasons for selling above are correct with our standpoint regarding selling.  I would add two more though:

 

4)  When the behavior of management creates ethical conflicts or are not in the best interest of all shareholders

5)  When the position has increased to such a size, where the risk to the portfolio becomes significant if an extraordinary one-time event occurs

 

I think some managers pay attention to "4", but many ignore "5" simply because there is a bias on retaining the holding and not incurring capital gains.  You should never fall in love with your stocks, regardless of who is running it...Buffett, Prem, Steve Jobs...doesn't matter.  That fifth reason is what makes the difference between the good managers and the great stewards of investor capital.

 

In regards to "4", that is very important to us, because while we don't place any tangible value on the manager during the calculation of intrinsic value, we do put weight on it when we invest.  Two very good examples in our case are when we invested in Steak'n Shake and Chanticleer Holdings.  We sold Steak'n Shake due to Sardar's recent behavior, even though the company and stock were doing great.  We retained our holdings (although we did make a mistake by selling some to realize tax losses) in Chanticleer, even as the company was struggling and having a tough time closing acquisitions, because we knew Mike Pruitt was going to also take a hit and not simply do anything to solely benefit himself.  That is huge in our eyes, and it will play a significant role in who we stick by and who we don't support.

 

But ultimately, the price relative to intrinsic value is the biggest reason to buy, hold or sell.  Nothing else is close!  Cheers!

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Sup Tim

 

I used to read your blog a long time ago. Being quite small and an individual I typically really sell when I find something else or on a material change in my thesis. You are correct when something moves up it kinda loses its sexiness and I tend to move on.

 

How is the money Management world treating you?

 

 

RRJ - LUK does the same thing.

 

Value guys are funny. I remember one guy saying, we like to leave something for the next guy  :). Whitman has the most interesting sell strategy I have come across.

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Finding something better than what you have is certainly a good reason to sell.  I prefer the something better to be something I have owned in the past since I will then be more familiar with it and less likely to make a mistake. Failure to sell when the thesis changes is a mistake many continue to make.  While we don't try to do it, we often create an alternative thesis, which is probably based more on hope than reality, to justify owning the stock.  A bad outcome does not mean that it was a bad investment.  If the process was done right you are still going to have occasional bad results.  Anyone who has ever played poker knows you can do everything right and still occasionally have a bad outcome. 

 

As for me, the money management world is treating me good. It has been a interesting journey.  Just over ten years ago I came across Marketocracy that said it was looking for good money managers outside of Wall Street.  I did well and got some opportunities to write articles for them.  In 2004 I quit my corporate job to work for Walker's Manual writing a subscription newsletter on quality otc stocks.  In 2006 I started my own fund.  Later that year Forbes.com did a nice feature article on me.  Things were progressing fairly well until the 2008 crash scared off some customers (mostly the large ones).  Thought I was going to have look for something else to do.  Thankfully, I met Zeke Ashton of Centaur Capital, and that eventually led to a sale of part of my business and an introduction to some great investors. 

     

 

 

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Tim thanks for the quick response. I am still trying to figure out how to break in, and stories like yours always help. Its been a good 5 years, and its nice to know us Corporate folks have a shot. I remember buying Parlux from your blog. That was more when I had no idea what I was doing though. Its been an interesting few years.

 

Zeke seems like a nice guy based on the articles I have read, and he is based in Austin (the second best city in the US). I look forward to his Q&A on gurufocus.

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It seems a lot of you guys invest in buying 50 cents in a dollar. So you buy at half the IV and sell when it reach you evaluation of IV. I understand it's important to keep a good margin of safety when investing, and everyone prefers to buy an undervalued stock, but I am not sure this is an investment pattern that suits me. I must admit I prefer buying safer stock at maybe lighter discount but offering good long term prospects. So if I evaluate that a company can grow IV at, let's say 10 or 12%, I rather buy it and keep it instead of looking for more important discount elsewhere. In this case, even if the stock reaches its intrinsic value rapidly because finally Mr Market recognizes its value, I will not necessarily sell because I know IV should keep growing. I could sell before if reasons 2 or 3 are met though. So I must admit I have difficulties selling at IV if I am looking for stocks with IV that keeps growing overtime. It doesn't seem to work really well with the buy and hold approach that I want to pursue.

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