So markets are at a high and in many ways it can benefit us. Apart from swelling our prides, it can add value in terms of having a portfolio clean up by giving away the over-priced stuff. And bull markets are not known to last forever. So it might be the right thing to dwell upon this subject for a while.
Pitfalls to avoid
Obviously, the above line of thinking i.e. selling the ‘over-valued’ means that one knows a lot better than others. Market prices reflects future cash flows anticipated from the business. And higher those stock prices go, higher are the in-built expectations from the company.
At one level though, especially during times when market is enthusiastic about the company in question, those growth anticipations goes through the roof – as its sky rocketing stock price would suggest. So selling it might make sense. Right?
Most of the times, especially when you are sitting on some hefty gains, one might think like doing so. After all, if the stock is priced to perfection then how can one go wrong by not selling it to its eager buyers? Well, sometimes you could go wrong.
Don’t think so? Then check what Rosenfield, one of the investing greats, had said in an interview with Jason Zweig about his sale of Intel Shares in 1980 which is published in the book Concentrated Investing–
“On its sale, the Intel investment had generated a profit of 4,583 percent. Rosenfield told Zweig, “I wish we’d kept it. That was the biggest mistake we ever made. Selling must have cost us $50 million, maybe more.” Zweig didn’t have the heart to tell the then 96-year-old Rosenfield that the shares he sold would have been worth several billion dollars in 2000.”
Consider this an extreme example (!), but the moot point is there are some pitfalls to be avoided before making a sell decision.
Not all businesses are the same
Future cash flows are easier to predict, in a certain range, for some businesses than others. And market expectations can swing quite wildly for the latter than the former.
Hence, while arriving at a decision – whether it is buy or sell decision – one needs to think deeper. After all, this is what investing is all about – trying to bring down your frequency of error and its magnitude.
In case of a sell decision, there could be a significant difference between the rate at which one thinks a business can compound its earnings and what that business end up actually achieving over the years.
Following are those ‘hard to tell’ business-types about which one needs to be doubly sure before arriving at a ‘sell’ decision.
(i) Asset-light businesses: By definition these are non-capital intensive businesses. For a moment stop and think how did the Indian IT companies grew at 20-30% CAGR over last 2-3 decades and simultaneously remain debt-free at all times? I believe it was a combination of global outsourcing demand + domestic pool of engineers + low capital intensity. After all, office space along with those desks and chairs, could be rented out right?
Also, some of the businesses which operate on float i.e. negative working capital are actually paid to grow instead of paying up to grow.
Whenever such asset light businesses see strong structural uptick in demand, they can step up their size with relative ease and cater to it. And it can also do so vice-versa.
Think how opposite is the case with capital intensive businesses like cement & steel. It takes them 4-5 years to add capacity. And by the time it comes up, demand cycle might have already turned upside down leaving them with surplus capacity and excessive debt.
Hence, instead of jumping to sell at some modest pick-up in demand, sit back and at least give it a shot of how things could look like 5-7 years down the line under different demand situations.
(ii) Non-linear businesses: If you ask me what could be even better than an asset light compounder – a neatly built non-linear business should be it. Non-linear businesses means those which need little incremental capital or expense outlay to grow its revenues. Google, Intel, Microsoft and our home grown Naukri.com are some of those types. Think about the regret which the seller who sold these years or decades back would have today!
But then there is lot of survivor-ship bias involved here. For every one Google there are dozens of those companies which ended up being bankrupt while trying to be one.
Hence, when you have yourselves owning one of those non-linear types which is showing positive signs of life and which markets have also noticed, don’t just run to the door as yet. Think scenarios. And if so seems fit, sell.
(iii) Surplus resources: Capital intensive businesses but with surplus resources, which are currently undervalued by the market, for one reason or the other, could temporarily achieve the status of an ‘asset-light’ type. The tenure of this would depend upon how much surplus are those resources vis-a-vis the demand environment.
Think about those NBFCs and banks which are currently operating at well below the permissible regulatory threshold of leverage. Also, some of these are currently operating at levels below their respective peers. Those are surplus resources which could be deployed if industry so demands.
Another example could be a manufacturing company operating at sub-optimal levels and which could cater to much higher demand levels by a combination of increasing utilization levels & brown field expansion.
(iv) Superior cash generating businesses: Businesses with strong internal cash generation and close to zero debt can go ahead to invest and meet demand as the situation may warrant.
Ideally, a growing industry with long enough run away and strong cash generation capacity along with low debt levels could create lot of value overtime. So even if you wish to sell it given the enthusiasm around the company, plan to repurchase it as and when the tide goes down – as it generally will.
By no means is the above list conclusive. Instead, its an attempt to make us think deeper before we think of running towards the door. Irrespective of your past gains or losses, it is important to think and act like business owners at all times – be it while buying, holding or selling it.
Let’s not allow speculators – who are propping up the stock prices – to increase our error rates. We alone are enough!
Personally, have found this to also be the hardest part of equation i.e. arriving at a range where one is confident enough to give up his stake. And finally there may not be any right or wrong decisions but something you are comfortable executing it. After all, there is a limit to which one can expand his temperament.
If holding something outrageously priced keeps you awake at night, it could worthwhile trading it off for a sound sleep!