Portfolio Management: When to Sell Part 3

In part three of this series on when to sell, I’m going to explore more concepts that help me to decide when to liquidate a position. You can find parts one and two linked here.

The grass is greener on the other side

The first of these is undoubtedly when I identify a better opportunity for my capital. If I have a share at £7.50 with a price target of £8, that represents a 7% potential capital gain but if I spot a stock trading at £2 that I think should be valued at £8 then that represents a 300% potential increase! If I’m confident in my research (and can’t identify an obvious reason why the second company is so underpriced) then why wouldn’t I sell out of the first company to move into the second.

This tactic is also linked to portfolio size – the more concentrated your portfolio the higher the returns (and the risk). I don’t tend to run a particularly concentrated portfolio (I usually fluctuate between 20 and 40 positions) but I do have a hard limit at 40. As I start to move towards this ‘upper limit’ I will attempt to identify weaker positions in the portfolio to prevent over-diversification and ensure my capital is deployed into the best possible opportunities.

I have also recently (in the last year or so) started ‘buying in pairs) where I sometimes select the best two companies I can identify in a sector and compare their performance over time. In theory, this increases my likelihood of picking the ‘winner’ but also comes with increased trading costs and the risk of ‘cluttering’ my portfolio with suboptimal companies. As such, I don’t intend to hold the weaker of the pair for more than 24 months unless I’m struggling to identify a clear preference for one over the other.

Losing interest

Some opportunities just fail to materialise. I have some legacy holdings which seemed like great investments at the time but have since failed to do much of anything. Their dividend yields are consistently at the top end of my portfolio but the share price has bounced within a tight range – sometimes at a small loss, sometimes at a small profit, but always returning to my average share price. After a few years of holding these shares, my patience can run a little thin. Excellent companies should be able to innovate, grow margins, generate increasing dividends etc. If a company is not doing this but simply ‘surviving’ there isn’t necessarily anything wrong with it; it just isn’t necessarily what I’m looking for in an investment.

Taking too many gut punches

Some investments just don’t work out. I consider a loss of capital of 40% or more to be a ‘big hit’ – such poorly performing investments are inevitable but best avoided. My ‘hit rate’ on such investments is currently 10% of all trades. If you relax the definition to be any loss of capital then that rate increases to 11%. An 89% success rate isn’t bad, but you could get even stricter and look into how many trades beat inflation and growth in the stock market – without getting too repetitive, I would estimate my rate here would fall to around 80-85% which still seems acceptable.

Of course, part of achieving this means cutting out the real ‘clangers’ in your portfolio well before they can do any damage (or better yet, not investing in them in the first place!). Although I wouldn’t say I keep a ‘close’ eye on my investments in that I’m not obsessively monitoring them every day, I do spend a fair bit of time considering changes and strategies to protect my capital.

Some companies, no matter how initially attractive they may seem, are really just landmines waiting to explode. One bad announcement leads to a second and before you know it you’re 40% down and falling further. It’s a truly horrible feeling. You wonder why you didn’t sell at the first warning, or the second, and now you’re at the third and wondering how much worse things could possibly get.

In my experience, these companies rarely turn around. A profit warning or two is to be expected, but as soon as you start to read about accounting errors or board members quitting en masse, it’s time to sell and move on.

The key thing at this stage is to consider what went wrong and if you could have foreseen it. I was speaking to an investor who was heavily into a cloud gaming firm called Wandisco (Ticker:WAN), back in 2018 and convinced it was going to the moon. He’d started buying into the company in 2017 at a little over £8 a share and was convinced it had serious potential. By October 2018 his shares were worth less than half his average buy price but he was still pushing the company at every opportunity he could. The shares staged a brief recovery in 2019, rallying to about £7 in February, before drifting back down to £4.50 as the year progressed.

Was there anything my friend could have done to avoid this tragedy? Yes. Wandisco had never turned a profit by 2017 (and three years later, still hasn’t) and it has nearly doubled its issued shares, vastly diluting shareholder’s interests. Rule number 1 on my investing checklist is to never, ever invest a company that hasn’t turned a profit in the last two years (as a bare minimum!).

Get caught out once but learn from it. Forget all the overblown hysteria about the ‘limitless pipeline of opportunities’ and ‘transformational programme’ and look at the figures. If a company is not profitable now and never has been, why should that change in the future?

I have a bad feeling about this…

I’m not generally one for acting on ‘feelings’ when it comes to investing. My focus is mostly on eliminating emotional and following a logical, tested and robust analytical process. Having said that, there are some times when I simply don’t feel right about a company. Perhaps I was expecting an RNS update or perhaps the results are slightly delayed. Perhaps the price isn’t moving the direction I thought or I’ve been reading about wider sector/competitor issues. It’s hard to put your finger on exactly why, but you just don’t feel comfortable with the position.

Sometimes, this is nothing more than an overactive streak of paranoia but other times I just can’t shake the feeling. When this happens, I try not to overact. I’d rather walk away from the company than have my gut feeling be proven right, so I’ll sell out and move on. This can also be extended to buying a company; sometimes I just don’t feel the company the way that I’d like.

Portfolio Management: When to Sell Part One

Portfolio Management: When to Sell Part Two