In an ideal world, we would never sell an investment. We spend a lot of time and energy hand-picking great companies that can deliver attractive returns for investors over the long term. But we live in a dynamic world - far from utopia! Making smart decisions to sell is therefore an important but often overlooked part of the investment process.
There are three key times we might sell an investment
Firstly, if our 'Investment Thesis' or rationale for owning a company changes permanently for the worse. Like a great castle, if our company's 'moat' narrows then it will be a matter of time before its competitors lay siege and breach the walls. For example, there may be changes in technology over time or we may lose confidence in the management team to make decisions that create value for shareholders. In the case of recent exit Abano Healthcare, the benefits we expected from its corporatised dentist business model were not accruing and so we sold our position (at a price comfortably in excess of the current takeover offer).
Secondly, if the valuation becomes too rich then it can be a poor investment for years. That said, we do not often exit companies purely on valuation. Great companies can make us look foolish by finding ways to create value that we did not account for in our valuation models.
Thirdly, we are always looking to replace moderate conviction investments with higher quality ideas.
We use disciplined processes to make good 'sell' decisions
Many investors succumb to biases that are part of human nature. ’Anchoring' to the price you paid and feeling the urge to buy more shares as the price falls is an example of a common bias. Buying at a lower price makes sense, although the mistake here is not properly scrutinising whether the prospects of the business have changed for the worse. It can be psychologically difficult to sell a bad investment at a loss, because crystallising the loss means you are admitting you are wrong and will never break even on the trade. On the flip side, it can be equally difficult to let go of a former rockstar performer that has passed its prime. We need to watch out for these emotions clouding our judgement.
To avoid these pitfalls, we maintain and monitor 'Thesis Maps' which outline our investment thesis and what we expect to happen over time. We check that proof points of our thesis are occurring.
If we are having doubts over an investment we will also ask ourselves some of the most fundamental questions: Is the company's 'moat' as strong as it was when we first invested? Do customers still love the product? Will the business be materially bigger in 5-10 years’ time? If I had no existing position, would I buy shares in this company today? If the answer to these questions is 'no', then the writing is on the wall.
Judicious sell decisions mean our 'Smart Active Management' style enhances returns
Sky TV is an example of how technological change can alter the prospects of a profitable company. For many years, digital satellite was the best delivery mechanism for TV in New Zealand. Sky had rights to the best content locked up. But the empire started showing cracks when Coliseum Sports secured the rights to Premier League football in mid-2013 and the cracks spread when Netflix launched in 2015.
We had owned Sky TV but fully exited our position in the NZ Growth, Premium NZ and Kingfish funds at above $4.50 when we saw its moat narrowing. Passive investors continue to own Sky TV shares as part of the S&P/NZX50 index. At the current price of [$0.93], these passive investors have worn a painful decline of ~80% since we exited.
We measure the value we add from our sell decisions versus the counterfactual of keeping them in the portfolio, to make sure our process is working and we aren't falling victim to any biases. We are happy with our recent scorecard of exits and the returns they have added for Fisher Funds clients.