Value.able TV #3: When should you sell?
It’s a common question. Stockbroker recommendations often travel from ‘Buy’ to ‘Hold’ then back to ‘Buy’, and then all of a sudden ‘Ceasing Coverage’ appears. Rarely is a ‘Sell’ mentioned, let alone maintained for any length of time.
So the question remains… should you sell after the stock market has fallen 511 points? Or when the share price of an extraordinary A1 business falls by as much as 26 per cent?
“Of course not, Roger!”, I hear Value.able Graduates shouting from the rooftops across the country.
In Chapter 13 of Value.able I describe my five rules for when to sell. In this video, I will elaborate on Rule # 1: No junk policy.
I will assume 1. You are a Value.able Graduate, 2. You have changed some part of the way you think about the stock market. I will also assume you can confidently pick an A1 company from a basket of so-called ‘blue chips’.
Your mission: Go through your portfolio. Turn the stock market off and look at the businesses you own. Are you blessed with A1s? Or is your portfolio full of ‘blue chips’ that fail to make the A1 grade?
If you are yet to join the Graduate Class, click here to order your copy of Value.able immediately. Once you have 1. read Value.able and 2. changed some part of the way you think about the stock market, my team and I will be delighted to officially welcome you as a Graduate of the Class of 2011 (and invite you to become a founding member of our soon-to-be-released next-generation A1 service).
Value.able TV #3 was recorded at Montgomery HQ on 5 August 2011.
Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 9 August 2011.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Kent Bermingham
:
Roger, congratulations on introducing ValeAble TV, it is great hearing the facts first hand and receiving info relevant to the moment, as they say a picture is woth a thousand words.
Roger Montgomery
:
Thanks Kent.
Grant Duggan
:
I still think its only early days as i have reserved a bit for times like this in my SMSF and did not pull the trigger when the discounts were there. Time will tell hope i get another crack at it, but after going in early on previous occasions,thought i might let the storm settle a little or maybe I’m just getting greedy. Oh well if anything in this game, the best anyone can take out of this is patience will pay off if you are prepared to wait long enough. And i know Roger has tried to remind us of this on many occasions, pity it took me this long. Time to turn off and wait again for those juicy bargains, the difference this time compared to only twelve months ago is i know what quality is. Thanks to Roger and blog. By the way Roger any word on the street when the new service might be available?
Greg Mc
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I suspect you’ll get your chance Grant. It is hard to conceive that the gyrations are done and dusted after a couple of days down and one up. Patience will pay, as you say.
Sean
:
Ross Gittins wrote a great article on this whole shemozzle in the SMH yesterday. Calling for calm from the panicking lemmings. He quotes nobel prize winning economist Paul Samuleson as saying: “sharemarkets have predicted 9 out of the last 5 recessions!”
With the media a veritable feeding frenzy feasting on this negativity and doomsday predictions this is difficult I know. Our psychology tends to lead us to follow the crowd and with economic commentators sensationalising and bombarding various media with the end is nigh grist for the mill, it’s sometimes understandable.
But unless you’ve had a call from your lending broker/ bank etc calling in a margin loan then selling shares in good quality companies on the basis of this generated fear at the expense of sound fundamentals is folly.
An economist: someone who will explain to you tomorrow why the predictions he made yesterday didn’t come true today.
Wish I had some spare cash to take advantage of all those people treating as permanent that which is temporary.
The world is going mad……
Scotty G
:
A Tale of Two Crashes
2008/2009
A an ‘investor’, whom we’ll call Scotty G for anonymity purposes has woken for work at 0500 to see that the Dow is off 700 points. He nervously heads in to work to check what it means for his portfolio of ‘blue chips’. He’s down badly and it’s only made worse by the fact that he is in a margin loan which he kept at a ‘conservative’ 50% level of gearing.
His ‘great’ stock picks are not holding up well in this environment and his ‘genius’ ‘value plays’ like buying Babcock and Brown at $7 because ‘its fallen from $28 and surely at a quarter of the price it represents value.’ He had imagined himself some sort of Buffet-ian hero, stepping in to a falling market and making the tough buy call that would surely pay off. No actual analysis is done to back up these calls.
Finally he is 1% off a margin call. He is tense at work, snapping at friends and chewing a red pen. He capitulates, calls his broker and sells out including his ‘value pick’, Babcock and Brown at 70c.
He feels relieved to be out but is bruised and jaded by his experience. He vows to return someday and do better but doesn’t know how.
2010
Our ‘hero’ comes across a beacon of light in a sea of information. It is the Valueline column in the Eureka Report penned by a knight known as Roger M. (name changed to protect the innocent). He follows the link to the Insights blog and is astounded that the information he has searched for is all here. He eagerly orders the Tome of Wisdom (Value.able to some) and reads it in one sitting upon receiving it. Wheels click in his head and light shines in the dark. Could it be so simple? Knowing what something is worth and then refusing to pay above it? In fact, demanding a discount? He set off on to his journey for the Grail.
2011
Our hero is now equipped with a spreadsheet devised from the Value.able rule book. He can value companies quickly and decisively. Many don’t make it on to the spreadsheet as he can now spot a ‘Babcock and Brown’ coming from a mile away. Stock ‘tips’ from colleagues can now be waved away. When they ask why he tells them. If they say he’s crazy, he smiles and feels at peace. He knows he is still not perfect but he’s a darn sight better than he was 3 years back.
The markets turn down. The spreadsheet is rechecked. MCE and FGE are added as they shift below his 20% discount rate. JBH is added soon after. The markets shift lower. But reassured by the facts this time, and not the hype, he buys more of the above. Markets shift lower still. Figures are checked and rechecked as more great businesses come within range. The panic of a fall is now replaced by a calmness and certainty that a anchor of value provides.
The markets finally slide steeply over several days. Finally some of his best targets are in range. VOC falls, then MTU a company he has waited ages to acquire and finally DCG. Sadly, ARP refuses to come within range but he his patient and does not chase it. He retires to his castle (lounge/bar) content with the work he has done, happy to await the next chance to hunt and switches on the sport, deftly ignoring the news and business channels hosting ‘experts’ eager to proffer their take on why things were the way they were. He feels at peace and sleeps soundly at night.
Ok stripping out all the ‘poetic’ and imaginative stuff this is pretty much how it went in real life. I suffered a loss due to poor decisions with no research, I found Value.able, I converted (or got innoculated as some of the greats say) and took advantage of the recent situation. And I do sleep sound at night.
Thank you Roger for your willingness to share and to all on the blog for the same spirit of camraderie. I look forward to many years of sleeping soundly at night.
To Value.able and to Value!
Ken D
:
Hi Roger,
I happened to take a look last night at 2 hypothetical portfolios I constructed based on MQRs you posted late last year.
Hypothetical portfolio 1 consists of 29 MQR A1 companies. Hypothetical portfolio 2 consists of 27 MQR A2 companies.
I have these portfolios set up in system which provides various performance measures (can’t wait for your new A1 service).
Apart from the fact that the A1 portfolio is still in the black based on one year returns (in contrast to A2 and large cap portfolios), what immediately caught my eye was the high ROE values right across the A1 portfolio. To illustrate this I have constructed a table (below) which shows the frequency distribution of companies according to ROE classes. This is presented for: 1) the hypothetical A1 portfolio; 2) the hypothetical A2 portfolio; and 3) a portfolio of the 28 ASX listed companies with a current market cap greater than $8 billion.
ROE A1 A2 m cap>8b
_______________________
0-10 0.0 14.8 25.0
10-20 6.9 29.6 32.1
20-30 31.0 25.9 35.7
30-40 41.4 18.5 3.6
>40 20.7 11.1 3.6
_______________________
The porfolio of A1 companies stands in stark contrast to the large cap portfolio and even the A2 portfolio. The average ROE for the A1 portfolio is 34% compared to 21.5% for the A2 portfolio and 17.7% for the large cap portfolio.
Now, if I only had access to your new A1 service, I’m sure I could quickly filter this A1 portfolio on a value criterion (e.g. MOS) and a forecast performance measure (e.g. projected change in intrinsic value) and likely identify, at this point in time, some candidates for a truly value.able portfolio.
Although these results would probably not surprise other Value.able graduates given, by definition, an A1 company would have high ROE, this little exercise served as a reminder to me of two principles in ‘Value.able’:
1) ‘Following the approach to stock selection outlined in ‘Value.able’ will result in a portfolio that itself becomes a benchmark of quality’ (p241); and
2) ‘To keep it simple, just avoid companies with low rates of return on equity. Any company generating a return on equity around or less than a bank account is uneconomic and most certainly not worth the risk (p97)’
….. or, as you simply state here on Value.able TV – ‘start by throwing out the rubbish’
cheers Ken D.
Roger Montgomery
:
Nice work Ken. Thanks for keeping us in the loop. And Yes, the A1 service will do all that and a whole lot more.
Rici Rici
:
Interesting, but on this point i politely disagree with Roger.
I am happy to hold ‘average’ companies so long as i receive an adequate compensation through a significant discount to intrinsic value. (and remember for some companies, Rogers quality ratings can change over time, so something that is an A1, doesnt always remain an A1 over time)
Where i totally agree with Roger, is the stupidity of holding average or below quality companies that are still trading above intrinsic value (as time will work against such companies, where as time will work in the favour of ‘good’ companies).
In the current market correction there are a number of ‘average’ companies that have seen their share price obliterated, so much so, that their ‘look through intrinsic value’ has significant upside potential.
Look through in this case, because some of them are cyclical, non-resource companies, so i am valuing them on a cyclical mid-point.
The best part about rogers book in my opinion, is not the focus on A1 businesses, instead it provides the ability to create a logical framework to ‘value’ a share.
This truely is valuable.
Roger Montgomery
:
Hey Rici Rici,
The great thing is your suugested approach is followed by many very successful fund managers in the US that have been praised by Buffett et al. There’s a multitude of approaches that work.
garry
:
Hi Roger,
Great value add for us graduates, especially in such testing times.
As a late entry to the valuable graduate team, I also own a few shares in great companys trading at a discount to what I paid. I can sympathise with Scotts comment below, but maybe when investors are closing accounts and selling all there shares, we must be at or very close to the bottom of this selloff. I did keep a few dollars for times like this, and today added a few extra to the portfolio.
With all the help you have given the graduate class, there is one thing some of us may need to work on ourselves, unless of course you can write another book, and thats the phsycology of share investing..Be greedy when others are fearful, is easier said than done.
Before reading your book I may have been a seller instead of a buyer today, but I did manage to see some value in ANZ, FGE, MCE, SMX, FLT, WOW…many thanks again
Roger Montgomery
:
Thanks Garry. Temperament is avery important part of investing and there is only a little I can do to have an impact. As they say, the longest journey on earth is the one from the head to the heart!
Dino
:
Hey roger
Do you beleive the average investor is at an inherent disadvantage>>
Example fund manager gets wind of sales slowdown (eg zicom) via industry contacts or his network and sells out of the stock.
The average investor can use eps forecasts and forward looking director statements etc but lacks a network to reel in how the company is travelling currently since his assesment yesterday or a week ago etc
Roger Montgomery
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Yes perhaps. But founders selling stock constantly is public too and the primary reason for our sale.
Rod
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The definition of a market analyst is someone who has an even-money chance of predicting yesterday’s crash.
Roger Montgomery
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..and would you say economists make sheep look like independent thinkers?
Graeme
:
That made me laugh and thought of this oldie.
What is the difference between economists and meteorologists?
Meteorologists can at least agree on what happened yesterday.
Richie
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Roger, fundamentals only exist as profits when sentiment is positive in this market. I have been shopping and my bags are full. I have to say I was one of those who sold just because of the panic attack. With your help, and my general view of the bigger picture: eventually inflation/demand will force assets to rise, particularly energy and commodities. When I locked in 5 year term deposits at 8% back in 2008 and again in 2009 the girl at westpac bank looked at me like I was a fool and said “you should put a deposit on a house”. In my head I thought: this is my cash money for total capitulation. We are not there yet, but every pay day Im beggining to purchase business others are letting go of. Thank you for adding to my education.
Roger Montgomery
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Thanks Richie. And well done.
andrew
:
Roger, what are your thoughts about the Bega Cheese IPO price of
$2? Regards Andrew
Roger Montgomery
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Don’t really like it Andrew,
I did the analysis on the weekend. If capital intensity, modest margins, exposure to volatile commodity markets (albeit with attractive prospects) and rising capital expenditure is not enough to scare you, perhaps a meagre 7.5% return on equity pumped up by a debt to equity ratio of 60% will. You need to seek and take personal professional advice.
andrew
:
Thank you for your input
David Sinclair
:
Hi Andrew and Roger,
Another useful insight that I picked up from a different blog (which will remain namesless) is that, following the IPO, approximately 75% of the shares in Bega Cheese will be held by the current owners. As the current owners are the dairy farmers who sell their milk to the company, that represents a massive conflict of interest.
David S.
Geoff Cruickshank
:
WOW under $24 today. I thought that looked OK and bought a few. Lots of others well down, ZGL, SWL
Roger Montgomery
:
We did too Geoff. But we also expect (hope?) to buy more at lower prices.
Geoff Cruickshank
:
Me too. Keeping some powder dry for some real plundering!
Ash Little
:
Yep,
I hope to see some generationally lower prices in the next 12 months….
I thought 2008-2009 was a once in a lifetime opportunity……..Fingers crossed it’s coming again.
Ian
:
did I really see the market do what it did today or am I dreaming?
Don’t follow the market lemmings but look for quality companies at a discount to value.
fortunes may be made and lost at times like this.
As lemmings they march to the end of a cliff,
Ne’er opening mind to “why” or “what if.”
Immersed in a world lacking knowledgeability
Teemed with utter stupidity.
Roger Montgomery
:
Thank you Ian. As I have been suggesting: Keep Calm and Carry On.
Ian
:
No panic here Roger.
Over the last week I have purchased shares in 4 great companies that I have been watching for quite a while. I hope, with a fair amount of confidence, that in 2 or 3 years time I will look back with satisfaction on the return from these great companies bought at good prices.
Roger Montgomery
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Great Ian, would you like to share their names. No obligation of course.
Churchill
:
Hi Roger,
enjoy reading your blog.Very interesting.
Churchill
Roger Montgomery
:
Thanks Churchill.
Uni
:
Hello & Nice job everyone. I see value everywhere on this blog. Thank you.
I started by getting my hands dirty on a very small investment while reading books. I concerntrate on value straight from the beginning but the more i read, the more i know that i was not value able. Suffering a virtural lost now but i am happy to pay for the school fee anyway. One of the lesson is to be patient for the value to come. I bought good bussinesses expensively.
Cant wait to get my copy Roger.
P/s: if possible, can anyone give more insights about lastest JBH info? I work out abit but quite a hard case for newbie like me. Is it still promissing?
Andrew
:
You are right about patience, the psychology element is very important to get right (more so than valuing and especially now). One company i look at has dropped 12% in one day. It is a good little test for people getting involved in value investing. Will you panic or see opportunity.
As for JBH-
My thoughts are that JBH still has the same competitive advantages they always have. I have however dowgraded it from my tier 1 group to tier 2 and i will explain why a bit later.
They will still earn quite a good ROE in the future and should be able to pay down its debt reasonably quickly. Depending on whether you strip out the restructuring charge they either had a decline or increase in net profit and forecast further revenue growth for 2012. My valuation for them has dropped for them based on the figures but that is only part of the picture.
I have downgraded them to my tier 2 (out of two) investment grade companys. This is because with the increase in debt has led me to struggle coming up with an accurate forecast valuation. This is i guess where people like Roger make their mint as they have the skills to better do this and their guesses are better than mine.
The debt confuses things for me. not because i am afraid it won’t be paid back, i am confident it will. The debt significantly lowered the Equity and pushed the companys net debt ratio to over 100%. As this debt gets paid back the equity will increase, i cannot work out at what rate this debt will be paid back and over how many years. I can there for not come up with any confident forecast valuation to act as a guide to future value so with that uncertainty i have relegated it to my lower tier investments but more likely will hold any fire on it till at least the HY accounts or i pick up the skills to come up with the said valuation.
The other reason which has cemented my downgrade was that i believe there are some significant changes to the industry coming through that they will soon need to address.
i think that better opportunitys are becoming available, specifically in regard to my tier 1 companys anyway so i am not worried about missing out on JBH.
As the company however still is attractive i will keep an eye on it though and will happily read what others think.
Please don’t take the above as advice, the above are my thoughts only and i am far from a professional at this point in time.
Uni
:
Thanks for taking time to reply, Andrew. You had the same points with Roger’s latest post.
I was worrying about the debt too and another fact is that, although they’re praised for customer service & friendliness of staff, I did not actually feel it everytime I come. If I dont feel right about a business, I may stay out.
And you’re right, there’s a lot of values out there.
SCOTT
:
i have closed my share trading account
never again will i touch shares
Roger Montgomery
:
OK. Thats sounds like its the right thing for you. Warren Buffett or Charlie Munger said if you aren’t prepared to see swings of 50% in your the market value of your stocks, then you shouldn’t be in the market. To counter that reaction, We have some investors who have called to ask for the forms to make additional applications.
Rici Rici
:
I think the logic is in the wording here:
‘my share trading account’.
Well if its a share trading account, what are you doing on this site.
In the most polite wording i can manage, why is a trader looking at an investment blog.
A trader should be basing their decisions on trading principles, not investing principles.
A trader’s execution will be proved right or wrong based on his ability to forecast price movements (up or down). Pure and simple.
‘Value’ should have no place in a traders vocabulary.
Steve P
:
Rici Rici – thats an interesting view and has a simple answer – to learn something. There are many smart traders about who use fundamental value to help create wealth. Similarily there are many investors who use technical analysis to time their buys and sells in conjunction with the estimation of value. A falling dagger is still very sharp if made of gold and covered in diamonds – happy to provide some examples. Learning is the key to success.
Andrew
:
I keep it pretty simple in regards to selling:
1- The uh-oh moment. You realised you made a grave mistake and sell immediatley
2- The godfather- I get an offer i can’t refuse. i.e the price is so high compared to value both present and future.
3- The former new car- Once quality but has gotten a bit dirtier and rustier. Company is no longer quality
4-Grass is Greener next door- There are better opportunities around at present than that particular company and the money would be better put in the other company. Very rare as i tend to hold but it does exist if the company is starting to mature out and growth stagnate.
5- The cash grab- I need cash for something else not related to investing but has a higher intrinsic value to my life than that company.
Otherwise, i am happy just to keep holding them, accumulating them as long as they are still quality.
P.S What type of karma points do i need to accumulate that will allow Cochlear to trade at a margin of safety for a little bit. Great results from what i see which isn’t a surprise. Cash profits appear to be above reported NPAT as well.
Roger Montgomery
:
Thanks for your input Andrew.
david
:
Roger,
Thank you for your extremely valueable insights in the last few days. Your voice of reassurance for those holding A1 portfolios is invaluable for those of us who have entered the market in the last 12 months following reading and digesting your book.
I have not even checked the value of my portfolio in the last 10 days , but am sitting watching and waiting for further declines in A1s with cash in hand
Roger Montgomery
:
Hi David,
Our fund is still 70% cash thanks to a process that evaluates intrinsic values for individual companies and in aggregate. We are gradually adding to the portfolio each day.
Keiron
:
I was in the process dumping any junk left when this market got it all done.
By my reckoning this market has another 10-20% to fall (from friday) based on equivalent valuation to GFC I. But then again if value holds and sentiment returns then good value stocks like A1 should be priced almost double what it is now. There is definitely real discounts appearing in this market.
Roger Montgomery
:
Thanks for your comments Keiron. Please keep posting.
Peter Dewar
:
Hi Roger,
While I didn’t watch the latest episode (no sound on my old, old computer!), I have read your book.
I just have the words of a well-known analyst ringing in my head (he has a column every Saturday in a national newspaper) when he was saying about the last crash how people held on and on to quality businesses but they dropped 50% so that means they have to gain all of that back to get back to where they were. Preserve your capital and get out, let the shares drop and then get back in again. You may miss the absolute bottom but you will have less losses.
Am still hanging in the market but getting nervous. :(
Peter
Roger Montgomery
:
Hi Peter,
Nerves are normal. I cannot tell you whether the market will fall another 10%, 20% or 70%. Neither can anyone else. AAd what if you sell know and the market rallies 30% and you miss out? The stark reality is that short term timing is something far too many people make comments about but do not demonstrate any ability at getting right. I will be the first to admit I don’t know whether the US will bounce tonight or drop another 600 points. Once we admit this to ourselves we can start to think about a valid alternative approach. FOr the last 9.5 years, the XAOAI has risen 1.3%p.a. You’d think investing in stocks has been a disaster. And yet ARB has risen 9.5% p.a. over the same period excluding dividends ( I believe there have also been three special divs). If you think you are an expert at “getting out, waiting for a drop and getting back in” then you should be doing exactly that. I am not so don’t even contemplate success from that approach. Was that expert telling you to get out in March or April this year when the market peaked?
Rici Rici
:
In a nut-shell, that ‘well-known analyst’ has primarily a trading focus.
Investing/trading is a bit like religion. From time to time ones beliefs will be tested. Its during such times, that one truely finds the answer to ones faith.
So all i can say is one must reflect upon ones personal attitute and provide his own answer to the following statement:
Am i a trader or an investor?, and as Mark Twain once said, never the twine shall meet.
In my opinion there is only one type of person who is worse than an investor or a trader. And that is the type of person who cannot make up their own mind.