Buying and selling stock requires discipline and well defined approach if you wish to be a profitable investor. I think a lot of us are very fixated on getting the highest price they can receive when they sell a stock. I think this is a very rational attitude to have, however to actually execute it well is a tough ask.
Consider the following
- Once a stock reaches its fair valuation, it is hard to know how far up will it go
- It is true that the upside is theoretically unlimited, it doesn’t mean that the valuations will support it
- At higher prices, the stock becomes riskier to hold
- At higher prices, there are more likely to be better alternative uses of capital in more undervalued ideas
I think in most cases, once you achieve fair valuation, it makes sense to take the profits and reinvest in other attractive ideas.
If you invest in a stock and get 30% return in an year, decide to reinvest in another stock for another 30% return, and continue this for 5 years, you will end up with 371% return.
This is better than waiting in 1 stock for 5 years to triple.
And getting a quick 30% return is often a matter of buying an undervalued stock with 30% – 40% margin of safety
This being said, I am not advocating to quit trying to maximize your selling price. What I suggest that we should stop stressing over it.
One way to do this, and this we are now implementing in the VSG Premium portfolio is to set a narrow trailing stop loss once the stock reaches its sell target.
If the stock keeps appreciating, we will keep following. If it stalls or turns a corner, we get out.
We have still traded on the valuations. This just adds a little bit of extra return every now and then.
Quick Cycling through Stocks is Important
I have been guilty of holding on to a stock for longer than necessary at times. At some point a great value stock devolves into a value trap and the opportunity cost of holding on is large.
Sometimes there are no better ideas anyway, so the lure of holding on is great.
This is a common problem although I am sure most investors have not stopped to think about it.
We have had situations where we expected a stock to give us X% return. It quickly reached half of it and then went on to languish for the next 2 years.
We have profits, so we hung on for the ride that stalled and never progressed.
At what time do you exit and release your capital?
I am evolving my processes to lean towards a quick exit instead of a buy and wait (buy and hold) approach.
Coming back to the initial thesis of this article
When you Buy a Stock is More Important then When You Sell it
See also: how to know when to buy a stock
If you insist on paying a low price for the stock, you are limiting your downside to a large extent. Not only that, a nice margin of safety also gives you the early target of how much you can expect to earn in profits on this stock.
Since buying price is much more under our control than the sell price, I believe we need to do all we can to get this right. Once we do this well, we can set up the processes to maximize our profits and minimize our holding time, which will keep our portfolio cycling and compounding faster over time.
Buying and Selling Stock at the Right Time is Important – But It is Not Enough
Our goal in investing is to compound our returns. Better faster compounding requires one or more of the following
- Invest in more high probability of high returns ideas
- Cycle through these ideas quickly to enter next compounding cycle as quick as we can, and,
- Keep doing this consistently over a long period of time
This is all there is to for consistent and successful investing.
Value investing gives you #1 (High Probability of High Return Ideas)
#2 is handled by a) breaking out of value traps, and keeping a closer focus on limiting the opportunity costs of waiting.
#3 is handled when you codify a large part of this process into systems and focus your expertise on doing only what you can do well.
In a later post I will work out and lay out a much deeper and better defined framework for speeding up the compounding cycle in value investing. We are working through processes in the VSG Premium portfolio and we keep adjusting as we go to optimize, so we are still developing our best practices in this area. Most books, guides and value investing programs teach you about the value investing process itself (#1) but not much is said about fitting the jigsaw pieces together to achieve this faster compounding cycle. Please note that by necessity the framework will be published at a conceptual level – the details are reserved for the clients and members of Value Stock Guide Premium.