Selling a Stock? How To Know When To Sell A Net Net

This is a guest post submitted by Net Net Hunter reader Xavier Hill. The thoughts and opinions expressed here are those of the author and may not reflect those of anybody else at Net Net Hunter.

How do classic value investors know if selling a stock is a good idea or not?

When buying Graham cigar butts, there comes a time when you have taken that last free puff and now there really is nothing left but the filter.

If for some reason you have ever taken a drag on a cigarette filter – like I once did after too many drinks at a party - you will know that smoking a filter is a very unpleasant experience. In fact it is downright disgusting and should be avoided at all costs. Yet for cigar butt investors like us, how do you know when you have reached the filter?

In my view selling a stock is far harder than buying, especially if you have had some big gains on a stock, you need to be mentally very strong to not fall in love with a stock that has performed well.

Still, there are a number of options available to determine when selling a stock, especially a net net, is the right move. The default and best logic to use is that used by net-net legend Walter Schloss. Schloss quiet simply sold when the stock reached its intrinsic value, which for him was often (though not always) when the market capitalization drew close to net current assets. This is a great strategy as it is clear and you can take the emotion out of the act of selling. Schloss loved to invoke Graham when speaking about how to sell, stating that “…a stock well bought is half sold. I think Ben was an expert in that area.”

The hard part is determining a stock’s intrinsic value as it changes over time and this is what makes selling hard. Indeed value investing legend Marty Whitman states that “value is a dynamic concept” and therefore the price you sell at is constantly changing. Within this dynamic environment there are some key concepts you need to consider.

Some Good Reasons For Selling A Stock

  • Firstly you need to understand the capital gains tax laws in your country and the capital gains tax implications of selling. This can be a big consideration especially if your stock has risen soon after purchase. For example in Australia capital gains on stocks owned for 12 months or less is 50%, yet 33.33% after 12 months. Make sure you consider the tax implications of any decision.
  • A change in the investment thesis. The reason I have been drawn to Net Net Hunter is that Evan does not just use a mechanical approach and simply recommend you buy a basket of net net’s thrown up by a stock screener. He screens for net-nets and follows this up with the critical analysis required to sort the valuable from the value traps largely via the core 7 approach, which I love. Still once you have bought a stock, you need to follow the company’s announcements closely and adjust your valuation of intrinsic value if there are announcements of significance.
  • Warren Buffett once said “there is never just one cockroach in the kitchen” If you begin to suspect a company to be using creative accounting in one aspect of the business, it is more than likely further bad news is to come. With that in mind, once accounting issues become apparent, I look to sell - immediately.
  • Always ask where does this stock fit relative to my portfolio? If a stock is nearing its intrinsic value and you have identified other companies trading substantially below their intrinsic value, then rebalancing your portfolio may be the best strategy.
  • Your stock all of a sudden becomes hot. From 2013-2015  Gold stocks were hated by everyone. Mid way through 2016 after massive gains, gold stocks were all the market could talk about during the gold stock mania of mid 2016 it was well and truly time to sell. If the market for your stock becomes hot – it is time to get out and put the money into other net-nets. As value investing legend Whitney Tilson says to sell a stock only when the market’s optimism is clearly excessive.
  • If the price is dropping and there is no identifiable reason as to why, then this is when you need to hold your nerve. Watching a stock fall for no apparent reason is tough – real tough. There is a myriad of thought around how to approach these situations, yet for me personally, if nothing has changed, then all that has happened is that the stock has gotten cheaper. Again we can reference Schloss who says “I never put a stop loss on my holdings because if I like a stock in the first place, I like it more if it goes down.”

Buffett's Limitations Make Selling A Stock Hard

Most of you reading this are in a position that Warren Buffett would envy. You can sell your stocks without huge tax implications and if you are a signed up member of Net Net Hunter you have a bag of other net-nets out there for which you can reinvest your profits.

Large money managers are managing so much money, that their investment universe is limited and they have to give far greater consideration to these issues - you do not. Indeed we can afford to stop dragging our cigar butts well before we reach the filter and with such low cost online broking services, the trading costs are also low.

So follow your stocks closely, remember that their value is dynamic and once they are approaching their intrinsic value, sell and reinvest in another well researched undervalued net-net.

Also for those of you who are members I strongly recommend you read Evan’s piece within the Resource Center about how to sell, where he provides even more detail and explains when to cut net nets that do not seem to be able to approach intrinsic value.

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