Thoughts on selling stocks, margin of safety and Mr. Market.
Recently two stocks I sold have had been on a tear. I sold Value Vision (VVTV) and IGO (IGOI) for some pretty substantial gains. I sold IGOI for a %120 gain after holding it for 5 months in a tax deferred account. I unwound VVTV in lots ranging from %870 to %300 gains in taxable and tax deferred accounts. The proceeds were re-invested in other positions which have performed well but in the short term I left some money on the table by not keeping the positions I had. Keyword here being short term.
I spend a lot of time thinking about my actions trying to determine if I made the right or wrong decision and if I made wrong decision, what lesson I need to take from the experience to apply to future endeavors. So of course one of the questions I asked myself is did I sell too early?
One thing I try to remind myself of in situations like this is “What the market does after you open or close a position really has no bearing on the quality of your decision.” While I would like to take credit for that thought, I imagine it was probably inspired by something I read from someone much wiser and with more experience under their belt. In essence what I am trying to say is that especially in the short term you should not use the market to judge your decisions. Even though the market values VVTV at over $7 and IGOI at over $4, that is not an indication on the quality of my decision to sell at cheaper prices.
Why? The answer really boils down to my investment philosophy. I started investing because I felt I strongly identified with the value investing framework. It makes sense to me and I feel confident that if applied with discipline it can lead to superior performance. While there are many interpretations of the value investing framework, one of the core tenets of value investing is the “Margin of Safety”. Buffett’s early investment style was influenced by his mentor Ben Graham. His style today is probably influenced by many people, two of which are Phil Fisher and his long time partner at Berkshire Charlie Munger. As his style has evolved the margin of safety is still a key component.
I entered both of these positions because I felt they provided adequate margins of safety trading at good discounts to their liquidation value and in both cases the companies had the chance turn around their business as an ongoing concern. So far they have both been making good progress and the market is treating them nicely for that progress. However lets not forget that these are not fantastic businesses with strong moats. So in my case, I bought them at discount to their value dead and got a premium because things worked out well. If only all situations could work out that way!
Both of these companies have a chance of success however once the margin of safety is gone there is nothing to backstop the value. Both of these companies have to execute with little or no error to continue on the upward path they are on. In this case the value the market puts on their progress is of no concern to me, what is of concern is the companies strength and the margin of safety I have if I hold.
Buffett has said that the best businesses are ones that can be run by a ham sandwich, because someday a ham sandwich will run them. I did not enter these positions because of their great business, I entered them because the market was selling them a large discount. They were Graham style cigar butts.
In the event that they enjoy great success long term the shares will appreciate accordingly, however in the event that they fail there is a higher risk of capital loss than I am comfortable with. Unlike companies with strong moats they can’t afford to make mistakes for a year or two. They must do a lot of things right.
So in conclusion when thinking about selling stocks do not think about the market. Think about the business and the margin of safety it offers at its current price. If you do that you will probably be right more often than you are wrong.
Disclosure: No positions in the stocks mentioned in this article.
Tags: IGOI, phil fisher, shopnbc, Value Vision, vvtv, warren buffett
January 16th, 2011 at 12:02 am
I’ve been thinking a lot about this one as well and came to a realization.
I sold too early and I couldn’t admit it.
One of the reasons to sell a stock is by making a mistake with the analysis. By we rarely hear the opposite. I made a mistake with my selling and should have actually bought back.
This realization wasn’t based on the stock price, although Im kicking myself, but the fact that the buyer of my shares knew more than I did.
I have a whole lot more reasons for why I made a mistake to sell both VVTV and IGOI, but the main takeaway is that if I made a mistake selling, I shouldn’t be scared to buy again.
Jae Jun´s last blog ..2010 Value Stock Screen Performances
January 16th, 2011 at 2:30 am
@JaeJun
I agree on buying back. You should look at it in isolation from a previous position. I.e The fact you bought a stock previously for 0.25 or 0.50 cents should not have an impact on what your assessment of what the current value is and if the current price offers the required discount to intrinsic value then by all means take advantage of it. I vaguely remember Peter Lynch discussing this exact topic in One up on Wall St.
However by your statement, I feel that you are saying you sold the companies far below their intrinsic value? From my perspective both IGOI’s and VVTV’s future cash flows are not well protected by a strong moat and contingent on a lot of things going right. Both face serious competition from companies with stronger moats and much more capital. This means IMO the MOS should be adjusted accordingly to reflect these risks. It sounds like you are saying even at higher prices you think the MOS was sufficient? Or are you referring to when the prices retracted to a lower level? For instance with VVTV when it went from $5 back down to $1.50?
On that note though, I am constantly re-evaluating my thought models and trying to understand what things I can do better in the future. Definitely a topic I would like to discuss to more.
January 16th, 2011 at 2:13 pm
Yes I was referring to when it dropped down below $2.
At current prices, I surely wouldnt be buying but there have been many new positive developments that has led to the increases. The new deal with Comcast taking over NBC was huge and the fact that they have been increasing their comps makes it even better.
The big reason for being undervalued previously had a lot to do with their carriage contracts with GE/NBC unwilling to invest in the business. Comcast will surely be different as their interests are aligned.
I failed with this investment towards the end based on a lot of behavioral mistakes. I got too attached, I was not realistic and rather than constantly re-evaluating an investment when business impacting news was released, I kept my target price the same and eventually sold out due to emotions.
Jae Jun´s last blog ..2010 Value Stock Screen Performances
January 16th, 2011 at 6:11 pm
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January 19th, 2011 at 9:25 pm
“You are neither right nor wrong because the crowd disagrees with you; You are right because your data and reasoning are right.”
- Benjamin Graham
Knowing when to sell is perhaps the hardest part about this business. The “rightness” of the decision should have nothing to do with subsequent market action. Mr. Market will go along his merry way without you after you sell. The only guy who buys the bottom and sells the top is a liar.
Wasn’t it one of the Rothschilds who, when asked the secret of his success, replied, “I always sold too soon!”?
Or perhaps you prefer the advice of George Soros…. “It takes guts to be a pig.”