Introduction

One of the most common complaints I hear from investors is that their advisors or brokers like to tell them when to buy, but never tell them when to sell. Whether those criticisms are fair or not, the sell decision is certainly the most vexing decision that investors face. Nevertheless, there are several clichés that people often turn to help with this puzzling decision.

One of my favorites is “do not pick the flowers and water the weeds.” Or another good one “let your winners run.” Although there is an element of wisdom, even profound wisdom within those clichés, they do present challenges. For example, how can you recognize the winner from the loser in advance? The same goes for distinguishing between a flower and a weed. With stock investing, most people consider a rising stock a flower, and a falling stock a weed. However, quite often it turns out to be just the opposite.

Legendary investor Peter Lynch in his best-selling book “One Up On Wall Street” said it like this: “Just because you buy a stock and it goes up does not mean you are right. Just because you buy a stock, and it goes down does not mean you are wrong.” The point is that a rising stock may be dangerously overvalued, while the falling stock price may indicate that the company is becoming a rare opportunity on sale. Understanding this comes down to realizing, without questioning, that the market is not always right nor is it always efficient. On the other hand, it would be more correct and accurate to say that the market, although not always efficient, is always seeking efficiency.

That last statement is why I rely on valuation so much. Over the years I have learned that the price of the stock will inevitably align itself with the intrinsic value of the business. Unfortunately, the timing of that occurrence is unpredictable. Sometimes, the movement back to intrinsic value (up or down) can be very swift, at other times the valuation anomaly can continue for a tortuously long time. Therefore, you simply cannot predict how high is up or how low is down. On the other hand, you can recognize too high and too low when you see it. Once that is accomplished, you can make a rational long-term decision. And more importantly, if you give that decision time to work itself out, it will also be a profitable decision.