When To Sell
I just finished reading The Warren Buffet Way by Robert Hagstrom and it shoots right up into the top five of my favorite business books. In addition to clearly explaining how to succeed in the stock market, I found an answer to a question no one has ever been able to adequately answer for me buried deep within the book. The question: "When do you sell?"
Before I discuss the answer as I understood it. Let's get a little background on what the "Warren Buffet Way" is. Essentially it means buying stocks based on the value of a company and not it's stock price. In Buffet's words, "Price and Value are not the same." The "Warren Buffet Way" means valuing a company based on the skill and integrity of its managers in addition to the company's financial performance. It means buying into a business by purchasing its stock only when its value is more than what is reflected by its price in the market. The calculation of that value is explained in several places in the book, so I'll leave that one alone. Also, the book explains on a few occasions that the discrepancy between value and price usually occurs due to unusual circumstances.
Robert Hagstrom goes on to discuss how he tried to emulate Buffet's style by picking the same stocks as his hero. What he found was that where Buffet's performance was above average, his was only average. This was because when Hagstrom purchased the stocks (after Buffet did), the market price of the stocks had already appreciated, so he couldn't get the full benefit of getting in on the stock at it's lowest price.
Earlier on in the book there was a short explanation saying that selling should occur when something better comes along. That was kind of vague to me until I read about Hagstrom's personal endeavors. At that point I realized that over time, the market will eventually catch up to undervalued stocks, and at some point it will eventually price them correctly. This is what Hagstrom was finding out first-hand. What he ended up doing was learning that it was better to buy by following Buffet's advice rather than by following in his footsteps.
For me Hagstrom's realization that he was consistently getting in late illustrated the initial point about when to sell; when something better comes along. Once the market price begins to catch up to the value that was so painstakingly researched (hopefully), and assuming the stock was purchased at a price well below that value, it's time to replace it with something else. That's when it's time to sell.
Hagstrom explains that selling on a repeated basis, and turning over stocks in a portfolio, not only increases yearly transaction costs, but exposes traders to capital gains taxes. This emphasizes even more the importance of holding a stock until it's value is realized. In this way you react to the performance of the business as compared to the market, not to market fluctuations, and you avoid capital gains taxes on the appreciated value of a stock's position. One example he gives is that if a stock is purchased, then doubles, or even triples, a person would be crazy to sell if he or she knows the business is not even close to realizing the value that was hopefully calculated when the stock was first purchased.
So there you have it. Buy high value stocks at low prices when the opportunity presents itself, then sell them when the market approaches that value AND something better comes along. Easier said than done, but at least now I know.
Before I discuss the answer as I understood it. Let's get a little background on what the "Warren Buffet Way" is. Essentially it means buying stocks based on the value of a company and not it's stock price. In Buffet's words, "Price and Value are not the same." The "Warren Buffet Way" means valuing a company based on the skill and integrity of its managers in addition to the company's financial performance. It means buying into a business by purchasing its stock only when its value is more than what is reflected by its price in the market. The calculation of that value is explained in several places in the book, so I'll leave that one alone. Also, the book explains on a few occasions that the discrepancy between value and price usually occurs due to unusual circumstances.
Robert Hagstrom goes on to discuss how he tried to emulate Buffet's style by picking the same stocks as his hero. What he found was that where Buffet's performance was above average, his was only average. This was because when Hagstrom purchased the stocks (after Buffet did), the market price of the stocks had already appreciated, so he couldn't get the full benefit of getting in on the stock at it's lowest price.
Earlier on in the book there was a short explanation saying that selling should occur when something better comes along. That was kind of vague to me until I read about Hagstrom's personal endeavors. At that point I realized that over time, the market will eventually catch up to undervalued stocks, and at some point it will eventually price them correctly. This is what Hagstrom was finding out first-hand. What he ended up doing was learning that it was better to buy by following Buffet's advice rather than by following in his footsteps.
For me Hagstrom's realization that he was consistently getting in late illustrated the initial point about when to sell; when something better comes along. Once the market price begins to catch up to the value that was so painstakingly researched (hopefully), and assuming the stock was purchased at a price well below that value, it's time to replace it with something else. That's when it's time to sell.
Hagstrom explains that selling on a repeated basis, and turning over stocks in a portfolio, not only increases yearly transaction costs, but exposes traders to capital gains taxes. This emphasizes even more the importance of holding a stock until it's value is realized. In this way you react to the performance of the business as compared to the market, not to market fluctuations, and you avoid capital gains taxes on the appreciated value of a stock's position. One example he gives is that if a stock is purchased, then doubles, or even triples, a person would be crazy to sell if he or she knows the business is not even close to realizing the value that was hopefully calculated when the stock was first purchased.
So there you have it. Buy high value stocks at low prices when the opportunity presents itself, then sell them when the market approaches that value AND something better comes along. Easier said than done, but at least now I know.
posted by moluv at 3:36 PM
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