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But specific insights into what might make him do this are few in his public pronouncements. Conversely, Philip Fisher in his book ‘Common Stocks & Uncommon Profits’ is quite specific. Fisher devotes an entire chapter to when (and when not) to sell a share, in the process citing only three bona fide reasons. I concur wholeheartedly with them.
The first is that a mistake has been made and the reality is a lot less favourable than you had originally envisaged. Every decisive person makes mistakes: so admit them, learn from them and resolve not to repeat them. Mentally rub your nose in it, as Charlie Munger would say.
Probably the best example from the ConBrio Sanford Deland UK Buffettology fund of having made this sort of gaffe is the short-lived investment in Tesco during 2013 (in at 365p, out at 332p just two months later). Investor ego is often assuaged when having made a mistake, the shares can be offloaded at a small profit. But unwillingness to take a loss, however small, often causes investors to hang on until they can come out even. Had I been so minded, we would still be sat on Tesco at over £1 a share cheaper.
Performance of stock vs index over 3yrs
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Source: FE Analytics
The second is that there has been a permanent deterioration in the franchise, its growth prospects or its management.
Disruptive technologies are a potent threat as investors in Eastman Kodak could testify. Faced with technological obsolescence, Kodak took some of its patent proceeds and cash flow and invested outside its core competence in another declining business, viz. printers. It ended up being decimated by its own invention of digital photography!
Sometimes it may be that after a spectacular burst of growth, a company has simply exhausted the potential of its markets. It moves to being a sluggard or stalwart, suffering a PER compression in the process. Probably the most common cause though is a change and deterioration of management. Either the new lot try to diversify or don’t have the ability, drive and ingenuity to keep the company on the straight and narrow. Recall Buffett: “You should invest in a business that even a fool can run, because someday a fool will.”
The third is that an alternative superior investment has been found but there’s no spare cash to buy it.
Though endorsed by Buffett and Munger, switching is potentially dangerous because you risk trading old gold for gilded plastic. Holding an investment for some time usually provides a good insight into the business’s characteristics – warts and all – that might be lacking in the new situation.
A switch example from UK Buffettology was the sale of AstraZeneca (AZN) and purchase of Dechra Pharmaceuticals (DPH) in 2012. Since the sale, AZN has risen by 67 per cent from 2843p to around 4750p whilst DPH has risen by 74 per cent from 500p to around 870p. After any sale, you always want the share price to carry on up because a sale at the top is akin to the ‘greater fool’ approach to investing. But 67 per cent?
One other possible reason is that in the midst of an asset bubble, market prices have become detached from economic reality. The dotcom boom and bust is a prime example of this and the bond market in 2015 may be the same.
I should add that for collective funds, there might be a need to liquidate some investments to meet redemptions and also that collective investment schemes have rules on just how concentrated a portfolio can be.
But worst of all has to be selling solely to crystallise a profit. One of the best maxims is to run your profits and cut your losses. Unfortunately, this runs contrary to how most people are wired.
Keith Ashworth-Lord is an investment director and fund manager at Sanford DeLand. The views expressed above are his own and should not be taken as investment advice.