Determining a good strategy for when to sell a stock is both important and difficult. In simple terms, your returns are going to come from two primary sources: 1) the reappraisal of an undervalued holding to its intrinsic value and 2) growth in intrinsic value. Many investors sell their holdings if the price appreciates to fair value. Others, like Buffett, Russo, Greenberg, etc. hold their stocks for the long-term and look for gains from growth in intrinsic value.
Both of these approaches work and have generated a great deal of wealth.
In September, I posted a 1999 interview with hedge fund manager Morris Mark. Mark began his career at First Manhattan, an investment advisory firm founded by Sandy Gottesman, a large shareholder ($2 billion) and board member of Berkshire Hathaway.
Here’s what Mark said about selling Coca-Cola.
“We sold it three years ago because the valuation it was trading at in relation to our anticipated rate of earnings growth on a near to long term basis seemed to be well discounted versus our rate of return objectives. Generally, we would sell a position when something bothers us, otherwise the sale is likely related to valuation.”
This strikes me as an immanently rational framework which I would tweak only slightly:
Sell a stock when, after due consideration of taxes and opportunity costs, its anticipated rate of total return is well discounted versus your rate of return objectives.
This framework works for all types of investing and allows for the fact that different investors have different hurdle rates. Of course, considerable judgment is involved in making this determination, but these are the type of issues that should have been considered carefully before making a purchase. If you can’t figure out how much intrinsic value will grow in the long-term, the stock should probably be sold when it is no longer undervalued.
I would love to hear your comments about when you sell a stock.