A couple of weeks ago, we looked at the thorny issue of when to sell stocks, looking at the use of stop-losses and focusing on the telltale signs suggested by Bill O'Neill that a growth stock may be getting toppy. As should have been obvious, this approach suits a growth-focused investor like O'Neill who's looking for rapid breakout, momentum stocks and wants to bail out of non-performing turkeys as quickly as possible. It's less clearly applicable in the case of value investing, where one is deliberately investing in companies that are ignored or misunderstood by Mr Market with a long-term view about the underlying intrinsic value and using a Margin of Safety. To illustrate this contrast, Warren Buffett hardly ever sells - indeed, his philosophy is that a lower price makes a stock cheaper and a better buy, although admittedly he's mainly dealing with entire companies, rather than parcels of shares.
A View from Philip Fisher
Although himself more a growth investor, Philip Fisher has laid out a more useful set of selling guidelines for value folk in chapter six of his book, "Common Stocks and Uncommon Profits". He argued that there were three general conditions which suggest that a stock should be sold:
- The investor has made an error in his/her assessment of the company.
- The company has deteriorated in some way and no longer meets the purchase.
- The investor finds a better company which promises higher long term results after factoring in capital gains.
One thing that seems to be missing from this list is when the company's stock price reaches intrinsic value (although that could be part of point 3). Interestingly, gut feelings or worries about a potential market decline are not reasons to sell in Fisher’s eyes - and rightly so, given the inherent difficulties of market timing. He explains:
“When a bear market has come, I have not seen one time in ten when the investor actually got back into the same shares before they had gone up above his selling price.”
Should value investors use stop-losses?
This is a very interesting question for value investors. As blogger TurnAround Contrarian notes, stop-losses are something of a taboo subject among value investors:
"The reason being EGO... Value investors including myself spend hundreds of hours researching a company. I like to think my work, which…