Using Discretionary Rules for When to Sell
Discretionary, or thesis-driven, investing differs from systematic investing by relying more on judgment, conviction, and deep research into individual companies. While systematic investors lean on rules and thresholds, discretionary investors build an investment thesis — a rationale for why a stock is being bought — and may ruthlessly cut if that thesis changes.
Interestingly, discretionary investors can still benefit from applying systematic principles. Recent research showed that threshold selling rules (discussed in the previous article) are useful even for value-focused, thesis-driven investors.
For example, in sectors that are harder to understand, these rules can provide structure and discipline where otherwise there might be uncertainty. This blending of rules and discretion expands the range of opportunities an investor can confidently pursue.
Peter Lynch’s Model of Stock Categories
A helpful framework for discretionary investors comes from Peter Lynch’s book One Up on Wall Street.
He divided stocks into several categories:
Fast Growers - Small cap, aggressive stocks that grow quickly at +20% per year.
Stalwarts - Decent stocks that still grow, but don’t climb with the speed and aggression of a Fast Grower
Slow Growers - A matured Fast Grower that matures but still rises above the market.
Cyclicals - Stocks that expand and contract rhythmically throughout the year.
Turnarounds - Often poorly managed cyclicals that rise and fall regardless of the market.
Asset Plays - Undervalued stocks that trade well under their deserved price. The market is yet to catch on.
When selecting a stock, it is important to identify which category it belongs to. For example:
A Stalwart may be chosen for safe, steady returns.
A Turnaround may be purchased with hopes of recovery, maybe after some signs of improved management.
A Fast Grower may be attractive for its explosive expansion.
An Asset Play may be targeted for being undervalued despite quality - be sure to have done your research.
The key benefit of this classification is that it clarifies the investment thesis.
It is crucial that you write down, or, at least, that you know your thesis for why you bought the stock. Knowing your investment thesis makes it easier to see when conditions change. Once a stock changes category, it’s time to re-evaluate the holding.
Each classification has its own sell rule pairings.
Case Study: Fever-Tree
Fever-Tree is a striking example. When it came to market in 2015, it was clearly a Fast Grower, with sales compounding at 40–50% and triple-digit earnings growth in its early years. For several years, it consistently beat earnings expectations.
However, by 2018–2019, the story changed. Growth slowed to 15%, then 3%, and expectations were missed for the first time. Fever-Tree had effectively shifted from being a Fast Grower to a Slow Grower.
The challenge for investors was that Fever-Tree remained a high-quality business with strong branding and products. But the valuation — at one point more than 60 times forecast earnings — was no longer justified by its slower growth.
The correct selling point, from a thesis-driven perspective, would have been when the company stopped meeting expectations and the growth phase ended. Selling then, though disappointing after the 2018 drop, would have preserved far more capital than holding on in hope.
This illustrates a classic dynamic: High Flyers (high quality, high momentum, expensive stocks) can quickly turn into Falling Stars when momentum shifts and valuations remain stretched.
What about Positive Changes?
Not all thesis changes are negative. Some companies transition into new categories for the better. Microsoft is a prime example. Once a mature Stalwart of the tech industry, it reinvented itself over the last decade through investments in cloud computing and, more recently, artificial intelligence.
Earnings growth accelerated to consistent double-digit rates, and the company repeatedly beat expectations. Broker upgrades followed, fueling momentum. Microsoft effectively moved into the Fast Grower category, showing how discretionary investors must adjust their thesis to recognize when a business model transformation has reignited growth.
In the UK, fewer companies manage this transition. RELX may be one exception. Traditionally a Stalwart, RELX has recently seen accelerating growth, driven by its big data and AI-related businesses. Earnings moved from steady single-digit growth into the double digits in 2022–2023.
This illustrates the importance of clarity: if held as a Stalwart, the thesis accepts steady growth and dividends. If held as a Fast Grower, expectations rise, and a failure to deliver would likely trigger a valuation reset.
Key Takeaway: Write Down the Thesis
The most important discipline for discretionary investors is to write down the thesis: why did you buy this stock, what category does it fall into, what do you expect to happen, and what is the turning point at which you sell? When results shift and the company no longer fits the original category, it is a signal to reconsider.
This clarity helps distinguish between short-term fluctuations and genuine long-term changes in trajectory. Fever-Tree shows how ignoring thesis changes can lead to painful losses. Microsoft and RELX show how adjusting to positive thesis changes can capture major opportunities.
In discretionary investing, success often comes down to honesty: acknowledging when the story has changed and acting accordingly.
But what happens if something unexpected happens? In the next article, we cover how to deal with seismic market events that could derail your entire portfolio.