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When to BUY, HOLD or SELL? (Part 2)

Sunday, August 18, 2013

Now, a question that people sometimes ask me with regards to selling is if they should cut loss? Well, from a valuation perspective, if we got into a stock which we thought is worth $10 a share at, say, $8 a share, and if the price should fall to $6 a share, should we sell?

OK, let us push this a little and let us say we thought the stock is worth $10 a share but for some reason, we bought it at $12. At $6 a share, should we sell? I think you know the answer.

Well, if we need the money urgently because there is an emergency at home, then, we don't really have a choice, do we? This is also why we must always use money we can afford to lose for investing. If we don't need the money, everything remaining equal, should we not be thinking of buying more if prices fall? This is why we must always have a war chest ready!



What we have to remember is that we want to buy at a price we would not sell at and sell at a price we would not buy at. This is a general mantra we should chant to ourselves and embrace its spirit.

Although we might think that $10 for a certain stock is cheap, it does not mean that it would not become $8 or $5 or even $2. Of course, if we are sure that our facts are correct and our reasoning is right, we should be buying more as prices fall.

Isn't it risky to buy more as prices fall? Of course, there is risk involved. Cheap could get cheaper. This is why I feel that some knowledge of technical analysis (TA) is useful. Purists in fundamental analysis (FA) will pooh pooh at this idea, of course, but unless we have very deep pockets, I think a bit of TA is useful. Anyway, I will talk a bit more about TA later.

Now, since we are on the topic of risk, some would argue that the level of risk associated with an investment should be considered when we talk about valuations. So, in the case of a business trust, for example, if it is perceived to be more high risk in nature, we would need a higher distribution yield before we invest in it, wouldn't we? I blogged about how this was the case for me when I invested in Perennial China Retail Trust: here.

The same goes with bonds although in the case with bonds, the holders are more lenders than investors and I blogged about bonds before: here and here.

Now, with interest rates rising and we are seeing higher coupons from 10 year bonds, the risks associated with REITs have risen. This is why their unit prices have fallen because Mr. Market is now demanding higher distribution yields for investing in a riskier instrument compared to 10 year government bonds. I am not saying anything new, of course.

As anyone can see, there is no one size fits all valuation technique.

So, some have thrown up their hands in despair and decided that they would only use charts to help them decide when to buy and sell. TA gives us a peek into Mr. Market's psychology. We then buy and sell based on technical signals which tell us the sentiments in the market. Of course, TA is about probability and never certainty. TA is about managing probabilities!

There is no exactitude, no matter which approach we choose to use. There are only approximates. As long as we are approximately right, we are better off than being exactly wrong. This is good enough. This is what Warren Buffett would say. If you have yet to watch the video on why he is the world's greatest money maker, watch the video: here.


The Warren Buffett Way
Make money using the tools available to every person.


Valuation is a subjective exercise and often, whether to BUY, HOLD or SELL, we have to rely on experience too. If there was a magic formula that worked all the time, Warren Buffett and any investment guru for that matter would never have made bad investment decisions in their careers. So, it is important to remember this and not become narrow minded when we think of valuations.

Related posts:
1. When to BUY, HOLD or SELL? (Part 1)
2. Recommended books for FA and TA.

32 comments:

Money Honey said...

wow! wow! wow! very useful guidance in both parts 1 & 2. It so simple to understand when you have always used examples to illustrate further.

Capricon said...

Hi AK
You are really in high spirits to get part 2 out ! I thought we might need to wait a while. :-)

You are spot on:
" What we have to remember is that we want to buy at a price we would not sell at and sell at a price we would not buy at."

Though i still did not get a answer to the question, but i do have new insights after reading the post.

May be next you can consider to use some practical examples from your portfolio, it would be very helpful.

Cheers.

Musicwhiz said...

I have politely disagree on a few points.

The mindset is that in investing, you should be prepared to invest money you can afford to lose (emphasis added). If this was so, then you've already started out on the wrong foot - because the idea of conservative investing is to preserve capital and seek a margin of safety. If you already step out into investing thinking that this is money you can afford to lose, then you'd have the wrong mindset and may take unnecessary risks. Whereas a prudent investor would perceive all money as being too previous to lose, and hence adopt a very careful attitude towards his investments. So, the idea is to prevent any permanent loss of capital - most people only look constantly for the upside but fail to take care of their downside.

Another point is that of averaging down. If an investment is worth buying at 80, then it should be even more compelling at 60. If your assessment of intrinsic value gives you a required margin of safety, then you should not employ a cut-loss strategy. Thinking of selling out and then buying lower is speculation - you are anchoring too much on the price of the security and paying too little heed to the fundamental and operational aspects of the Company in question.

Regards,
Musicwhiz

EY said...

Hi AK,

Not easy pulling this together. Good job! :)

Just some thoughts after reading the 2 posts:

1. Buy more at lower price
This works on the assumption that company fundamentals remain stable and long term prospects remain good. I think you've made this caveat. Not sure if there is any time frame reference on the 'long term' investment. Macro economic factors, broad market trends in the industries and sectors would affect operating environment of all companies. Nearly all competitive/ comparative advantages would have an expiry date depending on the PESTLE factors. FA would still be the key for long term investments.

Personally, I thought it is important to consider the opportunity cost in putting more money into the same stock even if it is fundamentally sound to do so. This approach would perhaps make sense if there aren't better investment opportunities. Here I'm considering different asset class, different markets, or different sectors.

But of course I do understand that these 2 posts are really only targeted at rationalising the decision in buying, selling and holding a particular stock. If you were to zoom out more, you'll probably need to publish an e-book! Maybe not fair for me to 'pick bones in an egg'.

2. 'Buy at a price that you won't sell, and sell at a price that we won't buy'

I'm quite intrigued by the quote. Buy decisions are made with the expectation that the stock price goes up. When it doesn't happen within a given time frame, we need to factor in opportunty costs to justify our hold decision. When the stock price retreats or plunges, we would be immobilised if we follow the mantra. If 'cut loss' isn't an idea we want to entertain, the hole we continue to dig might lead us six feet underground. Ok, maybe this is an exaggeration. But sometimes, the most rational thing to do is to bail and find another battle to fight.

Well, my ramblings here is intended to drive home just one message - be educated if we want to manage risk. If we learn to map out our investment strategy, decisions are merely part of the action plan. To invest or to trade? Check back at our strategy. To buy, sell, or hold? Ditto. Don't have a strategy? Then it would be high time to think about it before dabbling. If we manage our investments as a business, not having a plan for growth and another one for contingencies will leave us, at best, mediocre, and at worst, bankrupt.

Oh, I should qualify that I'm neither an experienced investor nor a very successful one. Made one too many mistakes along the way. Just dumping my 2 rupees worth of comments for the sifu(s) out there to enlighten me somemore. Thanks for the airtime! :)

INVS 2.0 said...

Admittedly, I bought some stocks at much higher prices than today but I am keeping them permanently for income. I don't mind "cheap could become cheaper" since I am not selling them away and incurring losses.

Of course, my war-chest is always ready for more price drops. :)

AK71 said...

Hi Money Honey,

I am glad you have found the blog posts useful. Took me quite a bit of work and time to produce them. Of course, we have to remember that they are just opinion pieces and nothing sacred. ;)

AK71 said...

Hi Capricorn,

I don't think I was in high spirits. I am more a worrier by nature and when I have something left unfinished, it bothers me. So, since Part One was already published, I just had to get Part Two out of my system ASAP. ;)

That quotation is one of the things I always say. Easy to say but harder to put in practice.

As for practical examples from my portfolio, I share openly what I do as and when there is an opportunity. So, it is not something new. :)

AK71 said...

Hi MW,

I did wonder if these blog posts would attract a response from you and I am glad they did. :)

When I say that we should use money which we can afford to lose for investing, I wasn't suggesting that we should be prepared to lose the money. Of course, we do not want to lose money. ;)

What I am trying to do is to impress upon readers that they should not be investing with money which they might have other needs for. So, if they should lose such money in an ill fated investment, they would be in dire straits.

It is possible that my late night writing was not very clear. So, it is good that your comment has helped to clarify this point.

As for averaging down, I agree. If an investment was good at 80, then, it would be even more attractive at 60, everything else remaining equal.

However, if we should be using money that we could ill afford to lose, then, it is possible that we could get very emotional over the paper loss and make irrational decisions. This is related to the point I was trying to make about using only money we can afford to lose for investing. :)

MrNg said...

Hi musicwhiz, missed your input and analysis at valuebuddies, keep up with your postings k... :)

AK71 said...

Hi Endrene,

1. Well, if we believe what Buffett says, long term would mean forever. These are stocks of companies which continue to do better every year. Hard to find but Buffett found quite a few.

I actually thought of whether to talk about opportunity costs and alternative investments. Although it would not have created an ebook, it would have created a sub blog post (or a few) that would distract readers from the main purpose of these two blog posts. You are right. :)

2. The quotation is one of my favourites and like all good quotations, it allows room for imagination. ;p

It lacks specifics. This is why I said that what we want to do really is to embrace its spirit.

For sure, we would have to create a set of guidelines for making sound investments and assuming that we did, during those difficult moments, this quotation is a nifty one to chant rather than going through in our minds a list of guidelines which we might have created. ;)

AK71 said...

Hi INVS 2.0,

As long as the fundamentals are sound, we shouldn't be selling as prices retreat. This is especially true if current prices give us nice margins of safety. :)

MrNg said...

It's difficult to maintain convictions when prices keep falling. When I bought YZJ, I already set aside funds to accumulate at different points if price get cheaper. When it does, I accumulate. When its near my 2nd trigger, I start to have doubts, what if my worst fear materialized? What if there is something I didn't Acc for, that despite the fact the quarter reports reports are still in line with expectations and the development promising. We need courage and emotional strength to invest, as much as brains. I think I am weak in both, albeit weaker at the emotional side. Luckily for me, it never went to my third trigger point, otherwise I will feel apprehensive . Despite having another war chest for bear market, I still chicken when price keep falling...

AK71 said...

Hi Mike,

We are only human, I always say, and to be human is to have emotions. I have done many things in life dictated by emotions. In those instances, sometimes, I regretted and, sometimes, I rejoiced. I am only human.

So, rather than tell myself or anyone else that we should not be emotional, I would say that we should put in place measures which would minimise the influence of emotions in our decision making process. This is pragmatic. :)

INVS 2.0 said...

No point selling a retreating stock if FAs are good. After all, stocks with good FAs are to enjoy rising popularity in years to come. For example, AIMS may look expensive at $1.45 now and I bought a small of it at $1.70+. Well, heavy capital losses but come to think of it, in 10 yrs time, it might rise to $2? Not to mention 10 yrs of dividends collected. :)

AK71 said...

Hi INVS 2.0,

Having a 10 year investment horizon is definitely a good idea for stocks which are fundamentally strong and set to grow.

In the case of AIMS AMP Capital Industrial REIT, it still has many properties which have under-utilised plot ratios and I blogged about these before.

For readers who missed that:
AIMS AMP Capital Industrial REIT: Making money.

There is definitely a great potential for more redevelopment and AEIs down the road. :)

Singapore Man of Leisure said...

AK,

Just as long it's not falling into the classic fundamental value trap.

It reminds me of the Black Knight by Monty Python:

http://www.youtube.com/watch?v=dhRUe-gz690

It's a scratch - average down at 60 cents having previously bought at 80 cents.

It's a flesh wound - buy again at 40 cents. What a bargain! 50% discount from our initial entry price!

Running away eh? Well, price is now 20 cents. Come back and fight me Mr Market!

The Black Knight always win!


PS: For someone who will not let a counter be X % of his total portfolio due to risk management or diversification reasons, will all these "unplanned" averaging down result in this stock now becoming a conviction buy and top holding?

Tickle, tickle. LOL!

AK71 said...

Hi SMOL,

That is a very good point! Would you like to share your views on "value traps"? I am sure everyone would like to hear from you. :)

Musicwhiz said...

Value traps are simply companies which look like they represent value, but are actually duds in disguise. Be very careful in averaging down on such losers - you'll end up much poorer from the effort.

As to how to differentiate true value company from a value trip, that's another story!

AK71 said...

Hi MW,

I can only hope that you would oblige. I am sure I am not the only one who miss your blogging efforts. :)

Musicwhiz said...

Sorry some typos in the previous post.

Should have been "As to how to differentiate a true blue value company from a value trap, that's another story!"

Well AK71, unfortunately I am unable to continue to blog because of personal reasons. And I still have a lot to learn and to refine my techniques - everyday is a learning journey for me.

Regards.

AK71 said...

Hi MW,

Yes, I remember why you chose to stop blogging. Well, I guess if you still read blogs and leave comments, you will still be sharing your ideas. Appreciate you taking the time to do so. :)

Singapore Man of Leisure said...

AK,

I can only share 2 traits good fundamental value investors have that prevent them from falling into the value traps:

1) Can admit when they are wrong.

Enough said. What else can we say if we are never wrong?


2) Excellent stock picker.

They know the company, industry, sector inside out. And that's not from summaries from sell-side analysts.

They do their own homework - prety much what MW used to do.

Valuing a business is not the same as valuing a stock ;)

Hey! Don't ask me! Since I can't value a business or stock, I stick with price action which I think I can understand.

Fundamental investing is too hard for my Pentium 4 chip...

LOL!

P.S. Want example? How about Creative? Or Chartered Semiconductor? Or Olam? How many really understand the fundamentals or business? Yet many know for sure their intrinsic value. Ha ha!

AK71 said...

Hi SMOL,

I cannot speak for others but I will readily admit that I am wrong if I know I am wrong! My face not more valuable than my money.

Question: How do I know when I am wrong? Ah, that is more difficult.

Valuing a company is definitely a lot more qualitative analysis while valuing a stock is more quantitative analysis. MW did a lot of good qualitative analyses before on companies he was interested in.

However, like you said, qualitative analysis is not a walk in the park. Ideally, we should know a business and the industry inside out but this is near impossible and I will readily admit that this is one reason why I have lost money to Mr. Market before. :(

Solace said...

Hi AK,

I always look closely at low PE stocks, but at the same time i am cautious of "value Trap".

Distinguish between growth stock and a growth company. For growth company, hype of growth has been work into the share price.

Growth Stock are stocks whose price will grow because they have unappreciated value or business fundamentals. We want to buy growth stocks but not necessarily growth companies.

So when i look at low PEs, i look at the quality of the earnings and the sustainabilty of the earnings. Ensure underlying buisness is sound before buying.

AK71 said...

Hi Solace,

Sounds good. Actually, sounds like material for another guest blog post. ;p

redponza said...

Hi,
I think we should focus on biz which is easy to understand and of high quality in terms of moat & management team. This will have the following advantage:
1.easier to calculate value
2.even if you are wrong, you have some buffer due to the quality of the biz

Buying low PE stock, small cap etc may be a value play but only if you can understand the biz well. But usually these are stocks usually these are stocks with less visibility.

AK71 said...

Hi redponza,

Thanks for your comment. :)

Off hand, I think there is a small cap stock with the visibility that you seek. ;)

Solace said...

Hi AK,

I will consider doing up a guest blog related to PE, earning, valuation etc. :)

However it will be a while later, busy w clearing some work b.f i put on the green uniform for reservist in the coming month.

In the meantime, markets is in for a rough ride, earning outlook seems bleak, need to pay attention to the market :)

AK71 said...

Hi Solace,

Serving the nation soon? Salute!

I am actually not too worried about most of my portfolio, having gotten in with comfortable margins of safety.

Anyway, looking forward to your next blog post. Thanks. :)

Miracle believer said...


The Buffet video link has expired. It blocked by BBC.

i found this https://www.youtube.com/watch?v=w-eX4sZi-Zs

Wondering is this the same?

AK71 said...

Hi MB,

Yes, that's the one. Thanks for this. :)

AK71 said...

Reader:
"Hi AK, are u looking at XXX, now that prices have dropped again? i first enter at $4, then $3.30... felt like i caught a falling knife..."

AK says what I do should not matter to anyone but myself. :)

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