If someone were to ask me, “what is the most challenging task for an investor to do well,” I would suggest “selling” as the answer. For someone like me who spends the majority of his investment energy in measuring value (as opposed to predicting outcomes), identifying attractive stocks and buying them is an exercise in my comfort zone. I think I understand well the principles of valuation and have enough experience to be confident that when I buy a stock, it probably will make me some money (this, in my opinion, is why value investing is so attractive to me – I generally buy stocks that are kind of “beat up” for some reason or other and usually have limited downside).
So, having bought a stock I consider undervalued, I wait, watch and wonder how high it’s going to go (while constantly monitoring all the important details, of course). Most of the time, I have some idea about the true or “intrinsic” value of a stock, but sometimes I simply feel that the upside could be “very large.” It’s in these cases where the real challenge of selling rears its ugly head.
Early in my career, I worked with some very smart, seasoned equity analysts at Brown, Brothers, Harriman & Co. Bob Dunlop was my first mentor, and he showed me how the value investing principles I had learned in business school could be applied to the real world. We uncovered a small company called Newell & Co. This firm made paint brushes, drapery hardware, bathroom scales and a bunch of other stuff that would basically bore you to death. But the company had a plan – it would acquire small companies that made similar products which were sold into the same retail outlets it sold into and eventually would grow much bigger. The company had a reasonably good track record of doing this to that point, but the company was still very small.
The valuation of the stock was very cheap, and it had totally escaped the attention of Wall Street analysts. We pitched the idea to the head of research and while he did not totally reject the idea, he said that the company would not pay for us to fly down and see the company. Eventually we were able to meet with the Newell’s president in our office and we were very impressed with the story. Shortly thereafter we initiated coverage on the stock with a “buy” rating. I don’t recall what our initial price target on the shares was, but a quick look at the long-term chart of NWL will show that the stock price increased 10-fold in the decade following our report. By the late 1990s, the stock reached the $60 level, a 30-fold increase from when we first discovered it.
So where do you think “taking profits” in Newell would have been a good idea? Up 40%? Up 100%? Up 200%? Granted, not every stock will show the kind of appreciation of a Newell (but this is one reason I really like the mid-cap area – this is where the Newells of the world usually reside), but the fact that some Newells may still be out there should give investors some reason not to pull the “sell” trigger too early. Within the universe of stocks I am closely following right now, I must admit there are none where I expect a 10-fold increase. Yet, there are some I think could more than double from here and there a few more where the upside could be “very large.” I would not want to take profits too early and miss all that sweet potential upside.
John Neff, the famous value investor who ran the Vanguard Windsor fund for over 30 years, had an interesting approach to selling stocks which is somewhat similar to mine. He always tried to sell a stock before it reached its full potential. His idea was that he could always use the proceeds from that sale to buy other undervalued stocks. Regarding his selling discipline he said, “Successful stocks don’t tell you when to sell. When you feel like bragging, it’s probably time to sell.” That’s probably the best advice anyone could ever give about when best to sell a stock.