WWII 067: When to Sell, Hong Kong Arbitrage, Elliott Associates Influences Gigamon ($GIMO)
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Main Topic: When to Sell and All About Sell Disciplines
This episode has been a long time coming.
The topic of selling is far less covered than the topic of what to buy. On this podcast, I won’t shy away from the difficult or the esoteric, and when to sell is definitely a topic that can be polarizing.
Before I go through my thoughts on when to sell, I want to mention that I have been a student of investing and public markets for twenty years and have studied day trading, swing trading, momentum trading, growth, value and everything in between. In every case, the only way a trader or investor (yes, there is a difference) can be successful is by mastering the sell discipline that will keep them out of trouble.
After two decades of studying and practicing investing in public markets, I ultimately became a disciple of value. Value made the most sense to me and I understood its concepts instantly.
That being said, my sell disciplines have been influenced heavily by value investing concepts, and I would say lightly by trading concepts. Experience has taught me to take what once were informal sell disciplines and make them formal.
When to Sell:
1. When you discover that your analysis was wrong due to some oversight, missed data points, miss-understanding of industry dynamics, feedback form customers or analysis of vendors. In other words, you were wrong to have bought in the first place. This sell discipline is not triggered by a decrease in the stock price of your purchase, but by the recognition that you made a mistake in the analysis. Often the best procedure is to sell out the full position as expediently as possible. It is best if you can sell into heavy volume to support the price if you are a large holder.
2. When and if the facts have changed. This may occur over time and is one important reason to follow closely the financials and qualitative aspects of a company. If you determine that the facts have changed such that a likely negative permanent change in the company or industry has occurred, it is best to exit the position. Stuff happens. On occasion, an industry with robust margins will suddenly engage in a pricing war that threatens to put everyone in the industry out of business. To preserve capital, sometimes it is necessary to get out of the way.
3. Opportunity cost is a major sell discipline that is one of the most commonly ignored factors. If you are holding a position in the number to by market share company in a stable industry with a thirty percent margin of safety, and the industry leader becomes available at the same margin of safety or better, you should consider trading up. Holding on to a position with a small loss and passing up this kind of “trade-up” opportunity is typical and is considered an “error of omission.” You knew about the opportunity but failed to act.
4. If a company with a limited future for increased cash generation is very over-priced by the market. This sell discipline is related to the “cigar-butt” investment method followed by Warren Buffett in his early days. Once a company with limited future upside approaches intrinsic value it is time to sell. This is especially true if the price over-reaches and becomes ridiculous compared to the intrinsic value.
5. Sometimes the sell discipline is actually not selling. If you happen to have been lucky (or good) enough to have bought into a business that has unlimited runway for growth, it may never make sense to sell it, even if the market has temporarily over-priced it. Here is what Buffett has to say about this:
“We never buy something with a price target in mind. We never buy something at 30 saying if it goes to 40 we‘ll sell it or 50 or 60 or 100. We just don‘t do it that way. Anymore than when we buy a private business like See’s Candy for $25 million. We don‘t ever say if we ever get an offer of $50 million for this business we will sell it. That is not the way to look at a business.
The way to look at a business is this going to keep producing more and more money over time? And if the answer to that is yes, you don‘t need to ask any more questions.”
Some of my largest returns in common stocks had resulted in holding for five years or more while the position doubled and then tripled. I did not sell along the way because that particular business had a big runway in front of it with everything from industry trends to macro trends as a tailwind behind it.
6. A stock you purchased has fallen 15% in price, you should double check your analysis to make sure you didn’t miss something important. If it has fallen 25%, triple check your work and you may end up triggering the number one sell discipline because you missed something.
7. To hammer home these sell disciplines, here are some reasons NOT to sell:
a. Just because the price has doubled since you bought it
b. Just because the price has surged 20% in one month
c. You expect a correction and plan to buy the stock again at a lower price (market timing).
The best thing that you can do is write out your sell disciplines as part of your thesis summary. For example, you say “I’m buying XYZ because intrinsic value is X and the margin of safety is 40%. I will sell if ___.
Ask JB: Is this Hong Kong Arbitrage a Good One?
I am investor from Malaysia and have been listening to your podcasts for the past few months. I was inspired by your latest podcast on takeover arbitrages to start looking for these type of investments in the Hong Kong Stock exchange. One such case which I found is a company named China Shengmu Organic Milk (HK:1432) whereby the offeror was an external party offering to buy a stake in the company for HK 2.25 per share. The share price closed at HK 2.05 as of 14-Apr-2017 presenting about a 9.75% spread. At the moment, the composite document (document which lists the important dates on EGM and last date of acceptances) has not come out and is expected only in end of April.
A few doubts I have about this are:-
1. The market cap of the company is about HK 13bil which is quite large which should make most funds notice it. I m wondering why such a large spread still exists.
2. The offeror intends to maintain the listing status of the company after the acquisition. How would this affect the chances of this spread being closed?
Could you weigh in your views if possible on this case and if this is a good arbitrage opportunity.
The relevant links are posted below
Thank you very much. Nick from Malaysia.
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