The foundation of Conscious Investor is to search for companies with all the signs of an investment that we would anticipate holding for a long time, perhaps even for the rest of our lives. Even though this is our intention, sometimes there are financially sound reasons to consider selling.
There are basically two reasons for considering such an action: there is a high probability that you can do significantly better with your money somewhere else, or you no longer have confidence about the future performance of the company.
Consider the first reason. You could consider selling when a company in your portfolio is still a great company but the forecast return is no longer attractive compared to that of other great companies. In other words, you can do significantly better with your money somewhere else. In some cases, it may even be that it is better to sell and invest in an interest rate product.
The foundation of successful investing is to employ your money in the most profitable way. If the STRETD calculations for a company in your portfolio are significantly lower than the return you can get on another investment, then generally you would sell the stock and transfer the money to the second investment.
Two words in the preceding sentence need to be emphasized: significantly and generally. Such an action only makes sense if all the signs indicate that the new investment will perform significantly better than the old one. We don’t start dancing in and out of stocks because we believe one is only going to out perform another by a few percent.
Also, this is only a general rule. For example, you also need to take into account the amount of confidence and understanding you may have built up with the original company versus the proposed new company. Moving from a familiar company to an unfamiliar one adds a certain amount of risk. Transaction costs and taxes may also come into play.
Another general comment is that, so long as we have reasonable confidence that earnings will continue to grow at a comfortable rate (or the dividend yield is at a satisfactory level), it is often better to hold on to the stock. In the 2007 annual report of Berkshire Hathaway, Warren Buffett gave his view on the importance of watching earnings:
I should emphasize that we do not measure the progress of our investments by what their market prices do during any given year. Rather, we evaluate their performance by the two methods we apply to the businesses we own. The first test is improvement in earnings, with our making due allowance for industry conditions. The second test, more subjective, is whether their “moats” – a metaphor for the superiorities they possess that make life difficult for their competitors – have widened during the year.
Regarding the actual calculations of return, notice here that we actually perform STRETD (or STRET) calculations on both the stock we are considering selling and the one we are considering buying. This is a very powerful feature of Conscious Investor since it allows the direct comparison of competing investments under suitable margins of safety.
The second reason that you might sell is because you no longer have confidence in the company to perform well in future years. In other words, it is no longer a great company. This could be because of such things as changes in management policy, excess debt, or lower profitability ratios. One thing to watch for is that the products and services of the company are not keeping up with the changes in consumer preferences.