Howard Marks has been writing investment-themed memos for 40 years. They are always thorough and thought-provoking.
In his latest missive, the billionaire co-founder and co-chairman of Oaktree Capital Management, majority-controlled by Canada’s Brookfield Asset Management, he tackles selling stocks, a topic he’s never covered in a memo.
When and how to sell a stock is often the most difficult thing an investor has to master.
Here are a few excerpts followed by a link to the full text.
by Howard Marks
Aphorisms like “no one ever went broke taking a profit” may be relevant to people who invest part-time for themselves, but they should have no place in professional investing.
There certainly are good reasons for selling, but they have nothing to do with the fear of making mistakes, experiencing regret and looking bad.
Rather, these reasons should be based on the outlook for the investment – not the psyche of the investor – and they have to be identified through hardheaded financial analysis, rigour and discipline.
Stanford University professor Sidney Cottle was the editor of the later versions of Benjamin Graham and David L. Dodd’s Security Analysis, “the bible of value investing,” including the edition I read at Wharton 56 years ago.
For that reason, I knew the book as “Graham, Dodd and Cottle.” Sid was a consultant to the investment department at First National City Bank in the 1970s, and I’ve never forgotten his description of investing: “the discipline of relative selection.”
In other words, most of the portfolio decisions investors make are relative choices. It’s patently clear that relative considerations should play an enormous part in any decision to sell existing holdings.
• If your investment thesis seems less valid than it did previously and/or the probability that it will prove accurate has declined, selling some or all of the holding is probably appropriate.
• Likewise, if another investment comes along that appears to have more promise – to offer a superior risk-adjusted prospective return – it’s reasonable to reduce or eliminate existing holdings to make room for it.
Selling an asset is a decision that must not be considered in isolation. Cottle’s concept of “relative selection” highlights the fact that every sale results in proceeds.
What will you do with them? Do you have something in mind that you think might produce a superior return?
What might you miss by switching to the new investment? And what will you give up if you continue to hold the asset in your portfolio rather than making the change? Or perhaps you don’t plan to reinvest the proceeds.
In that case, what’s the likelihood that holding the proceeds in cash will make you better off than you would have been if you had held onto the thing you sold?
Questions like these relate to the concept of “opportunity cost,” one of the most important ideas in financial decision-making.
Switching gears, what about the idea of selling because you think a temporary dip lies ahead that will affect one of your holdings or the whole market? There are real problems with this approach:
• Why sell something you think has a positive long-term future to prepare for a dip you expect to be temporary?
• Doing so introduces one more way to be wrong (of which there are so many), since the decline might not occur.
• Charlie Munger, vice chairman of Berkshire Hathaway, points out that selling for market-timing purposes actually gives an investor two ways to be wrong: the decline may or may not occur, and if it does, you’ll have to figure out when the time is right to go back in.
• Or maybe it’s three ways, because once you sell, you also have to decide what to do with the proceeds while you wait until the dip occurs and the time comes to get back in.
• People who avoid declines by selling too often may revel in their brilliance and fail to reinstate their positions at the resulting lows. Thus, even sellers who were right can fail to accomplish anything of lasting value.
• Lastly, what if you’re wrong and there is no dip? In that case, you’ll miss out on the ensuing gains and either never get back in or do so at higher prices.
So it’s generally not a good idea to sell for purposes of market timing. There are very few occasions to do so profitably and very few people who possess the skill needed to take advantage of these opportunities.
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