VALUE INVESTING
Inertia Selling

By Stephen Bland (TMFPyad)
September 7, 2001

Many value players experience some difficulty in deciding when to sell a share. This might be after a good rise or perhaps after a fall. The latter decision is possibly easier because if the fundamentals that depend on price have not changed then there is no reason to sell after a fall. In fact the fundamentals must in that case be even more attractive, so you hang on, buy more if you have the money.

Alternatively if the fundamentals have changed for the worse so that the share no longer has attractive value features then sell, no question, and take the hit. As a dedicated value player you must do this, instantly. Don't muck around, you do not want to remain in a share that is not a value share on whatever variation of the usual ratios comprise your version of the strategy. Only someone who was not dedicated to the game would hang on in this situation, hoping for a recovery.

One thing before I go any further. Whatever other antisocial personal habits you may possess, do not use technical analysis to decide on selling a value share, or buying one come to that. Yes, I know that this will cause all those hybrid TA/FA readers to come out with stories of how it saved them from Independent Insurance. Those are the exceptions. The only strategy that makes sense and money for value shares is value shares because TA is diametrically opposed to FA when it comes to value.

The much more difficult decision about selling occurs after a rise. Get one thing straight -- if your value share has a had a good rise you have won. In that sense there cannot be a bad time to sell because you will have made a decent profit. If you take my advice to never look back after a sale then you cannot go wrong if selling at a good profit. However, what prevents people from selling is the belief that more might be available before the share has exhausted its value bull run.

And this is the difficult bit. How much of the value has to evaporate before the investor decides that there is insufficient left to justify holding any further? This will vary from one person to another simply because not everyone uses precisely the same criteria when buying, but some people might suggest that the sell point comes when you would no longer buy at the current price. This idea does not suit me and many others I would guess. I will frequently hang on long after one of my four basic pyad criteria have been breached. Selling as soon as one goes would not allow sufficient profit to be made in most of my cases.

If I look at my own four basic pyad rules, then as the price rises, the first to break will be Price/Tangible Book in nearly every case. But since the price at which I buy may often be only slightly under book there would be no point in going in if I was prepared to sell just as the price goes over book because there would be an inadequate profit.

What I am saying is that there is a certain inertia that causes me to remain in a share, even though I would no longer buy it at that price. Consequently whether I would buy the share if I was looking at it cold as a potential purchase does not necessarily produce the same answer as to whether I should remain in a share that I already hold and which has given a fair increase to date.

There is a point, though, at which my criteria will have disappeared to a sufficient extent such that I am willing to make a present of them to my old mate, the next guy. If P/TB<1 has gone, that leaves us with P/E and yield. Debt is not price-related. The original pyad yield minimum is 50% over the yield of the market. I would probably exit therefore when the yield had breached this limit. Similarly with P/E going beyond two-thirds of the market's. I don't think I could live with two pyad criteria lost, in general.

Also, I will look beyond the classic value criteria to other factors for my sell signals to combine with the disappearing value fundamentals. One that I have mentioned before is tipster activity. Tipsters are a bit like rats. One might be a nice pet possibly. But a horde of them is not something you'd necessarily want running round your house. So one recommendation might be acceptable, depending upon who was making it, though even that one might be a good sell sign depending on other factors. But more than one buy recommendation and I am probably looking for the way out sign pretty soon. Let the next guy have it, any further potential growth is no longer worth the risk.

Another sell signal might be a large acquisition. Since my shares tend to be cash rich, it follows that many of them are tempted to spend this and more on a relatively substantial acquisition. A good sell signal. Too many takeovers simply don't work. In any event I am probably not willing to give them the benefit of the doubt.

But remember, whatever kind of value player you are, do not be tempted to hang past a certain point when the share has lost too much of its value. Once you do that, you are no longer in a value share, by your own definition. You have become the next guy.