You don’t make money when you buy, and you don’t make money when you sell. You make money when you wait.
The above is true. However, most of us don’t own entire businesses like Buffett, who enters into a “marriage” with the entire company. We need a consistent philosophy on selling. One that we can stick with.
Discounted Pies vs. Growing Pies
When you buy a company at a discount to intrinsic value, it can usually be placed in one of two categories: discounted pie or growing pie.
The Discounted Pie
The discounted pie refers to buying companies at a discount from their asset value. Not much emphasis is placed on growth or earnings power. Sometimes discounted pies may take the form of sum-of-the parts type investments. This is when the firms assets are potentially worth more than what the books tell you. Emphasis is placed on hard, tangible assets; It’s hard to buy discounted pies if the assets of the company are mostly intangible.
This is what you could consider classic value investing. Business quality is secondary. If you spot a deeply discounted business from realisable asset value, the right time to sell is when the price has reached its intrinsic value. If earnings are fluctuating, your risk increases post-intrinsic value prices. Normally I don’t preach diversification, but this might be an exception. Since these classic value plays are hard to find and vary in quality, it’s safer to buy a group of them instead of single, big bet plays. Additionally, a discount to assets is not the only thing to look for. You wan’t more cushion to your margin of safety. This can be a low P/E and heavy insider buying, as stated in the brilliant paper by Tweedy Browne.
Another approach to finding these classic value plays is to look internationally, like the late great Sir John Templeton. Venturing internationally may scare investors from developed markets. This is why a diversified approach is a sound MO. In a basket of discounted companies, some may fail. But as a group, over the long-term you should be looking at results that are, to quote Ben Graham: “Quite Satisfactory”.
The Growing Pie
Growing pies are businesses that year after year produce high returns on capital, have good moats and a long runway ahead of them. These are high quality businesses that Mr. Market is very aware of, and usually has priced them accordingly. Most of the time they are priced above intrinsic value, and the story has long ago taken over from the fundamentals.
The investor needs to know the difference between a great company and a great investment. Buying blindly into a great company even with a long-term perspective can be disastrous, if the price paid is irrationally high. A classic example is Microsoft. This was/is perhaps one the greatest companies of the modern era, and investors knew this at the turn of the millennia. However, if you bought at inflated prices in 2000, it would have taken you 16 years to regain your losses. Even with dividends giving you a “sense of income”, you would be looking at a below average return if you initially paid the inflated price. If you stubbornly held for 21 years to this day, you might be looking at 10% return (including dividends), but only after underperforming for a decade and a half first. And let’s be honest, are there really many of these investors around?
Buying into a great company is sound advice, but only at a fair price. As mentioned, these companies rarely trade for deep discounts. But getting them somewhat undervalued is still good. The reason is that at some point, these companies tend to sell for way above their intrinsic value. You can enter a position at a below-average price, hold for a very long time (due to the high business quality) and sell if the price gets way out of hand.
Perhaps the greatest part about buying into growing pies is the ability to swing heavily. These are long-term, big investments that compound at high rates for many, many years. When its raining gold, be out with a washtub, not a thimble. Buying with a margin of safety will prevent you from being wiped out and as the Oracle says: “Time is the friend of the wonderful business and the enemy of the mediocre”.
Holy Grail: Deeply Discounted Growing Pie
On rare occasions, you will come across the dream scenario: A deeply discounted, high return business with a long runway. These opportunities emerge during a public (but solvable) scandal or great panics. The latest we had was the two-week stampede of March 2020. It was a marvellous opportunity to pick any juicy berry for well below its worth. Mr. Market was behaving like a complete lunatic and giving you all these great companies for fire sale prices. Even just buying an index during this time would have doubled your money in a very short timeframe.
You don’t necessarily need a long watchlist of companies in your drawer when these times come. A great alternative is to look at what you already own. If you own high quality businesses that can weather the storm, it makes perfect sense to buy what you already own. Sometimes during great panics you may even be able to grab more shares below your initial buying price, depending on how long you’ve been holding. Remember, these great businesses need to be well within your circle of competence, and the circle may not be massive. You don’t need to be right about a hundred businesses, you only need to be right about a handful to do very well.
This may seem like common sense, but there is just one catch. During these rapid declines most people are disabled by fear. It’s only during these times that you reveal to yourself who you truly are as an investor. Do you panic and sell like the rest? If you know you’re going to be a net-buyer of hamburgers in your life, do you want the price of meat and buns to go down over time? Most individual investors are going to be net-buyers of stocks during their investing lifetime. Only in the stock market do people get sad when getting discounts. Never, ever interrupt compounding unnecessarily.
To conclude:
- Sell discounted pies when they’ve reached intrinsic value
- Sell long-term compounders only if the price gets totally out of hand
- When great panics emerge, look into what you already own and grab more
-IGTSKasimir
Further Reading
Warren Buffett – The Partnership Days (1956 – 1969)
Philip A. Fisher – Lessons From The 15% Man
The Best of Ben Graham – Security Analysis
Phil Town – The Compounding River Guide
Margin of Safety – The Most Important Thing
Intelligent Investing = Thinking In Probabilities
The Emotional Stages of a Value Investor
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