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The prevailing wisdom seems to be that: it never hurts to book a profit. To me that seems to be pretty dumb, and in my opinion, it almost surely isn't the way one should arrive at a selling decision.

If you were to Google or do a search on Amazon using the words in the title of this blog post, you wouldn't get any meaningful content. I mean, there will be tonnes of search results, but nothing that can be used in any practical manner for the layman investor which means you and me. If you were to search for 'when to buy' instead, there is an almost unlimited choice.

I consider myself to be pretty hopeless at the selling function, and hence I have spent a reasonable amount of time trying to hone this skill. Unfortunately, I don't have much to boast about, and I can confidently say that I have much to learn about the Art of Selling. I will just share what I have learnt so far.

Since this is a huge topic in and of itself, I have broken it up into various sub-segments. I don't propose to cover ALL of them in one post. But, in the fullness of time, I will probably get there.

Since the decision to buy or to sell is very subjective, one cannot have a ‘one size fits all’ kind of scenario or system. And, that is true for almost everything in the stock market. Before I go deeper into the ‘how’ , ‘when’ and ‘why’ to sell, there is one fundamental question that needs to be addressed.

First and foremost, each of us needs to answer the question: Which game are we playing?

Broadly, there are two types of games; one is Finite and the other is Infinite. A Finite game must come to a definitive end. There are known players and the rules are fixed before the game commences. An Infinite game is not bound by time. The rules keep changing, the participants change, and the game continues to be played.

So, a game like a hockey, football or cricket can be referred to as Finite. And, things like running a business, or even our everyday 'game of life', are infinite in nature. The moot point is that the stock market is an infinite game. Finite play in an Infinite game is inherently contradictory. That is another way of saying that, those who have a finite mindset, shouldn't be playing the stock market game.

I know that sounds harsh, but the if you’re investing in the stock market with a finite mindset, one doesn’t really have to bother about such profound things like the art of buying or selling. I am fully aware that the vast majority of ‘investors’ consider investing in the stock market as a speculative activity in which one has to just ‘buy low and sell high’ and since that isn’t as easy as it sounds, there is whole media ecosystem to ‘guide’ you in your endeavour.

To be fair, some of us do follow a mixed methodology by constructing two separate portfolios. One portfolio is for the ‘buy low and sell high’ kind of trades and the other one is where we are investing in the business, and not in the stock. This is doable, though I don’t know of many who actually have the fortitude and discipline to distinguish one from the other. The investing Gurus, are playing an Infinite Game, there is no doubt about that.

I think that context matters and hence all of the above is a kind of a disclaimer for readers, since what I will write is useless for the ‘buy low and sell high’ kind.

For those who want to dive deeper, the recommended reading is Finite and Infinite Games by James Carse and The Infinite Game by Simon Sinek.

With all of that out of the way, let me get to the actual post.

Broad Principles on Selling Stocks:

This is what the Gurus have to say about the ‘Art of Selling’:

Buffett

Warren Buffett was asked this question in a Q&A at some university in the early 2000's and his answer was that in the olden days he had more ideas than he had money. In those days, he used to assess the pros and cons in terms of the Earning Power of the stock that he wanted to buy and compare the metric with the one that he already held. Over the years, he has more money than he has ideas, so he pretty much doesn't bother about selling anything as long he doesn't come to the conclusion that buying the business was a wrong decision.

Munger

Question: Do you believe the valuations for electric car manufacturers are in bubble territory? Both Berkshire and Li Lu own BYD Company which you spoke highly of in the past. BYD sells at nearly 200 P/E. This is cheap compared to Tesla currently valued at over 1100 times P/E and 24 times sales. I know Berkshire is a long-term owner and rarely sells securities of high-quality companies it owns in its portfolio simply because it’s overvalued. For example, Coca-Cola in the past. However, is there a price too high that the company’s future profits simply cannot justify? And since we are on the subject of selling potentially overvalued security, could you provide your systems for selling securities?

Charlie Munger: Well, I so rarely hold a company like BYD that goes to a nosebleed price that I don’t think I’ve got a system yet. I’m just learning as I go along. I think you can count on the fact that if we really like the company and we like the management—and that is the way we feel about BYD—we’re likely to be a little too loyal. I don’t think we’ll change on that.

Question: BYD is in the Daily Journal stock portfolio with a very big paper gain. The stock has gained so much this year and last year. The stock appreciated probably way more than intrinsic value. How do you decide to hold on to a stock or sell some?

Charlie Munger: Well, that’s a very good question. BYD stock did nothing for the first five years we held it. Last year it quintupled. What happened is that BYD is very well positioned for the transfer of Chinese automobile production from gasoline-driven cars to electricity-driven cars. You can imagine it’s in a wonderful position and that excited the people in China which has its share of crazy speculators. And so, the stock went way up. We admire the company and like its position. And we pay huge taxes to a combination of the federal government and the state of California when we sell something. On balance, we hold in certain of these position when, normally, we wouldn’t buy a new position. Practically everybody does that. One of my smartest friends in venture capital is constantly getting huge clumps of stocks at nosebleed prices. And what he does is he sells about half of them always. That way, whatever happens, he feels smart. I don’t follow that practice but I don’t criticise it either.

To be honest, the above isn't very helpful for me and for all of those who don't have unlimited capital. I don't know of anyone who has unlimited capital that can be invested in the stock market. So, the Buffett-Munger wisdom is simply not applicable.

Berkshire Hathaway which is majority owned by Warren Buffett is basically an insurance business; they also have many investment and insurance subsidiaries. Float is what every insurance business has, and Buffett has been very successful in deploying this ‘Float’ in an extremely profitable manner. I don't want to get too much into the weeds about this, since it isn't germane to this post. Long story short, the ‘Float’ is what ensures that Berkshire Hathaway has more capital than investing ideas.

In one of its insurance subsidiaries, Berkshire had a manager by the name of Lou Simpson, who was in charge of investing the 'float'; and this gentlemen is also an investing legend in his own right. His thoughts on selling might make more sense to ordinary mortals like you and me.

Lou Simpson

We do not have any hard and fast rules on selling. We do not sell that well.
If I’ve made one mistake in the course of managing investments it was selling really good companies too soon.
There are a few factors that we look at. First, is this the business we thought it was? If you figure out that a business is not what you thought it was, that’s a bad sign.The second factor is the management, which can also differ from what you thought. Unfortunately, a lot of managements are very short-term oriented, and that can be another reason to sell. This goes back to the basic integrity and the focus of people in charge. The third factor is an overly high valuation, and this is often the most difficult, because you’re investing in something you wouldn’t buy at current prices, but you don’t want to sell because it’s a really good business and you think it’s ahead of itself on a price basis. It might be worth holding on to it for a while.

Peter Lynch

Peter Lynch, is another legend and his thoughts on Selling are:

Selling your winners and holding your losers is like cutting the flowers and watering the weeds.

One thing is very clear, and that is the fact the selling decision is way more important than the buying decision. As a result, it is a very, very tough decision to take.

I will stop here for the purposes of this post, since it is already getting way too long. This one has been more about framing the context of the selling decision and the thoughts of the Gurus on this topic. If you’ve read this far, stay tuned for the follow-up. Thanks for reading.

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