Mental Models discussed in this podcast:

• Opportunity Cost
• Rebalancing
• Coffee Can Portfolio
• Intrinsic Value
• Optionality

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Show Outline

The full show notes for this episode are available at https://www.diyinvesting.org/Episode106

When should I sell stocks? (Question from Patron)

There are a few key considerations: 

1. Opportunity Cost
   1. What else do you own?
   2. What is your current best idea? How much of it do you own?
2. Trimming Positions
   1. I don't like doing this. All-or-nothing for me.
3. There is a huge difference between selling into cash versus selling to buy a new stock
   1. Perhaps you consider selling to cash at a P/E of 35, but otherwise only sell if you have a better stock to put it in.
   2. I may be fine selling a stock at a P/E of 20 (that I think is worth 25) and buying a stock at a P/E of 5 (that I think is worth a P/E of 15). My return prospects are better.

What if my thesis was wrong?

You should sell a stock if you've made a mistake. If you were wrong about the thesis or your thesis has broken you should sell. 

This is hard to do and I struggle to do so myself, especially if the price has fallen substantially. 

Other Considerations:

• Coffee Can Portfolio
  • Seeking "Never Sell" stocks - only certain companies qualify
  • Benefits from a deferred tax liability (can become quite significant over time)
  • Preferable for individual investors. hard to implement professionally.
• Return Differential
  • Don't sell a stock because a new idea is 1% better. 
  • You want at least a 5% return differential.
    • Future returns are 5% when the new idea is 10%
    • OR future returns are 10% when the new idea is 15%. 
    • Don't quibble over small differences because those differences are within your margin of error. 
• Question from Patron: "Should I buy great companies during their growth phase and then sell when they lose their advantages?"
  • A few problems here.
  • It is difficult to predict when a company will lose its advantages.
  • Likewise, once a company is recognized to have lost its advantages, usually, the price deterioration has already occurred. 
  • If you want to maximize profits, you likely need to sell BEFORE advantages have been lost. 
• Positive Optionality and Selling Above Intrinsic Value
  • It is almost impossible to accurately calculate intrinsic value.
  • Consequently, it is likely a mistake to sell when a company reaches your calculated intrinsic value. 

Summary:

Many value investors lack a clear strategy on when to sell stocks in their portfolio. This decision ought to be based on opportunity cost, potential investment mistakes, intrinsic value, and return differential between old and new companies.