During the final week of September, I had two positions, Anglo Asian Mining and Digital 9 Infrastructure Trust drop by 20%+ in a single session. Both rebounded strongly the next day – the proverbial “dead cat bounce” but remain heavily underwater for recent investors. Despite this, I am still holding both companies and in this article, I want to expand my thinking about selling positions, what causes me to do so, the dangers of buying high and selling low, and why in 2023 I’ve been accumulating more than selling.
Investing for the long-term
As regular readers will be aware, I often write about the importance of watching the underlying business when investing rather than the obsessing about the share price. At the most basic, a share price is simply an amalgamation of buying and selling pressure. When more investors want to buy a share than sell, the price appreciates, and vice versa. Sometimes, these desires are driven by market intelligence, sometimes by guesswork, and sometimes by emotion. Sometimes, sellers are forced to liquidate as they require capital for other purposes. The decision to sell will also be made against the other assets an individual holds – after all, one person’s dirt may be another’s gold dust.
This is why it is so critical to have an independent assessment of value and never, ever, to become a forced seller of assets. Multiple studies have shown that time in the market is a much easier factor to master than timing the market. The table below illustrates my thoughts on this topic, with the blue line representing the ‘average’ investor, the red line representing an inexperienced investor, and the gold line representing an experienced and highly skilled investor.
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For the avoidance of doubt, I am defining an ‘average’ investor as someone that picked a broad selection of companies that are well diversified by geography, sector, and market cap. This is not someone with a concentrated portfolio.
For this average investor, I believe that the odds of picking an investment and generating a profit in a single week are small – less than 10% if consistently selling within a week and considerably less if selling within days. This reflects my belief that intraday movements are mostly random – driven by a host of uncorrelated factors that are almost impossible to decipher. For evidence of this, one only has to read the warnings on retail trading platforms, warning that the overwhelming majority of customers lose money when attempting day trading or using binary options and derivatives.
By contrast, the longer that investor holds their investment, evidence shows that the odds of being able to generate a profit greatly improve. By my own estimation, after three months we could reasonably assume that they would be able to sell around a third of their positions for a profit, assuming random distribution across global markets. After a year, I would expect this to increase to around 50% – if the investor held for five years for this to improve to 80%, and after 10 years I would expect that chances of making a successful investment to be well over 90%, again, presuming random distribution of ownership.
The more experienced investor, by virtue of their skill and education should be able to improve these odds. Within a year, they may expect to see a hit rate of 50%, increasing to 70% after three years, 90% after five years, and maintaining a small measure of outperformance against the average after this. This would be, in my estimation, a highly skilled and disciplined investor, well-trained and capable of accurate valuation, emotional control and careful asset selection.
By contrast, I would expect a significantly worse performance than average for the less skilled amateur. This individual may have an over-concentrated portfolio of highly risky assets, weak valuation skills, a tendency to invest in ‘story stocks’. They lack consistency, strategy and emotional discipline and as such invest in a basket of overvalued, poorly performing assets.
After a year, perhaps one in five of their positions are showing a profit, improving to just half after three to five years and never quite managing to catch up with the average after this. Providing they manage to avoid the very worst assets in the market, time in the market may help to generate some small profits for them, although they will never manage to compete with even the average investor.
Although I have little doubt that there are many traders who will vocally disagree with the short duration end of this graph, my approach has always been to invest for the long-term, and generally speaking I have found the above to be a fairly accurate depiction of performance over time. The danger, however, comes when market volatility scares investors down the duration curve from the tail end with a 90% success rate to holding positions for only a few years or less.
Don’t sell assets if noone wants to buy them
This danger becomes increasingly clear if you observe the last few years in the stock market. Many investors have bought shares in the last three years which have declined due to general market weakness. Prices in the UK are particularly weak, with many institutional investors abandoning the market in droves. Price to Earnings multiples are at multi-years lows for many of our most established businesses and investors do not have far to look to find assets with yields of 6, 7 or even 8% and significant discounts to Net Asset Value being readily available. It is clear that the UK is an unloved market – the question is, what to do about it.
Valuations can take many years to normalise, but if an asset is productive, cash flow positive, and paying me a return in the form of a dividend that I believe that I should hold it for the long-term. Although tempting, investors that sell in the current market are likely crystallising losses having bought at or close to previous 52-week highs, and now selling at or close to 52-week lows. The perceived justifications for this are multitude – losing patience or confidence in the management, losing patience with missing out on returns in foreign markets, and finally feeling so much “pain” that an investor simply has to capitulate. All of these are perfectly valid feelings, but if the investor truly capitulates in a bear market, then they are likely to be the living embodiment of \”buying high and selling low”, or in short, acting in exactly the opposite way to that required to manage a profitable portfolio.
I cannot pretend that I have never done this, but my focus on developing a valuation methodology that is independent of price means that I very rarely crystallise a loss. While some interpret this behaviour as loss aversion, I am fairly confident that it is instead a confidence in my own valuation methodology and willingness to invest for the long-term which prevents me from being scared out of positions at the bottom of the market.
A current example of this is my position in Secure Trust Bank, STB, which I purchased in 2021 at about £12 a share. Since then, the world has experienced a major spike in inflation, a major spike in interest rates, two sovereign debt crises (the US and UK), a banking crisis caused by the duration mismatch between assets and liabilities, and an on-going property crisis in China which is threatening to topple a multi-billion dollar conglomerate that many are likening to the 2008 crisis that took down Lehman Brothers and started the Great Financial Crisis.
Today, the shares languish around half my purchase price, about £6.30 a share, are on a forward price to earnings ratio of 3.1, have an 8.2% dividend yield and are priced at a low 0.35x their book value. The company is sat on net cash of £256m and has operating margins of around 20%. This does not look like a business that is about to go bankrupt and yet it is deeply, deeply out of favour with the markets which are pricing it as through the apocalypse is due to start tomorrow. Although I cannot see an immediate catalyst for price appreciation, I am far more confident that if I am willing to be patient, I will be able to realise a considerably higher valuation for the business by 2031 – roughly ten years from when I originally purchased it.
Of course, there are a great many reasons the company may be unloved by the market. Secure Trust Bank’s return on capital is a lowly 1.1%, earnings per share have declined since 2021, the company generates inconsistent free cash flow, making it difficult to value, and the dividend has fallen from a high of 83p per share in 2018 to just 45.1p in 2022 (although now three times covered compared to 1.8x in 2018). Fears about financial contagion from other institutions is worth considering, as well as potential defaults in a world facing a severe and prolonged cost of living crisis. Having said this, however, I still feel that the “animal spirits” of the market have markedly undervalued this business and that over the next ten years, it is more likely to achieve a higher than lower valuation from its current price.
Conclusion: Avoid buying high and selling low
My point here is not that every company is worth holding forever. Some businesses are genuinely low quality, or develop poor quality characteristics after you initially purchase them. Being blind to this reality is as bad as expecting that the current market price is a perfect reflection of the intrinsic value of the company at all times. Sometimes you learn new information about a company or the market it operates in which make it less attractive to hold for a long period of time. In these instances, selling the business is not an unwise course of action, but liquidating large holdings at poor valuations is a guaranteed recipe for destroying portfolio value over time.
Understanding why you have purchased an asset and undertaking independent analysis of the value and the role it plays in your portfolio are absolutely critical to your success as an investor. There are a great many reasons to liquidate an investment but be sure you are doing it for a fair price, or at the very least, for what you believe to be the most fair price you can achieve. I have met a great many investors over the years that have been scared out of positions by price action, switching for owning one company to another and then watching as their old company appreciates in value without them.
In a bear market, it is easier than ever to want to chop and change, and to give up all hope on the companies you once thought were wonderful but after two years of a global pandemic, inflation hitting double digits, supply chains collapsing, interest rates being hiked in most countries for nearly 18 consecutive months, a war in Europe, China’s property market slowly collapsing, and much more besides, can you honestly say that you are surprised if many businesses are having a hard time trading profitably or continuing to grow?
If I own a business for ten years, I expect one or two of those years to be challenging. If I am correct about my assessment of the management of the company’s potential, I hope that one or two may be exceptionally positive, but I never expect these as a given. By and large, I expect the company to operate within historical patterns, neither expecting them to ‘shoot out the lights’, nor to be fighting continuous headwinds.
Selling in the middle of a bear market may well feel like ‘cutting the weeds’, but without due care and consideration you risk cutting prize flowers that are simply waiting to bloom again.