VALUE INVESTING
When To Sell

By Stephen Bland (TMFPyad)
August 30, 2002

A common question amongst investors, and not only on the value board, is when to sell. The question can arise in all three possible events that can happen with a shareholding: they've gone up a lot, they've gone down a lot or they've more or less gone nowhere a lot.

Only mechanical investors are relieved of the responsibility of making this decision because of course their plan rules will make it for them, annually in the majority of cases.

Otherwise many people are perplexed by this point. Value, growth, ethical or just general non-strategy-specific investors all have to face this test at some point. There are a few buy and hold forever types around, but not many I suspect; except maybe income investors.

I was motivated to write this article (ed - originally published in November 1999) by a question from one of our value board readers concerning London Pacific Group (LSE: LPG), a share in which he had invested and is now showing a good profit in a short time. A share that appealed to me and which I introduced to the board a few months ago. After I wrote about them and, I will admit, invested heavily in them, they rose a little then fell back sharply. Quite a bit below my entry price. This can and does happen both with value and other styles as any regular investor will confirm. At that point someone referred to my concept of "smell" with regard to shares, commented that they smelt like a sewage farm. Nobody can call the bottom or the top. I go in when the share is a pyad share and LPG was that at my entry price. That does not mean it cannot fall further of course. Nor that it is certain to do well eventually. But I saw the risk/reward as heavily in my favour at my price, which is the point of the pyad approach. I believed it would do well. And when I believe in a share, believe me I believe.

Anyway a bit later, it started a terrific bull run and our reader, quite rightly in my view, became a little nervous about whether he should sell. I responded that if he was very nervous then better to take his substantial profit and go cash, not looking back. If anyone is showing a good profit on a share, then I see no reason to remain in if they are losing sleep over it. And it never hurt to make good profits.

As far as value investing is concerned there is some guidance on selling. Whether you use the pyad super value approach, or another version of value, the fact remains that the shares were bought because they satisfied a set of criteria that you set. If you made a good choice then the shares will have risen and the value will start to evaporate. The gradually disappearing value will be your sell signal. That still leaves some scope on exact timing but it provides an indication. Personally, I will sell when the deep value has gone. I will not wait even for the share to become averagely valued. Because I buy so cheap, this leaves plenty of room for fat profits to accumulate long before the share gets to that level, if it ever does.

If you are a committed value player like me, then the more the share ceases to show value characteristics the riskier it becomes. And as a value player you do not want to hold non-value or even slight value shares. Hence look for the exit. Other signs are the non-fundamental ones. When you bought the share it was unloved, unwanted, a dosser sleeping in a cardboard box. Everyone said it was no good. Suddenly brokers, the press, the message boards perhaps, are full of praise. In the same way as you went in on a contrary basis, think about leaving on a contrary basis. But little has changed with the share itself, so why the change in perception? Because a lot of what happens in the market in the short term is not about the real value of shares, but about perception. The market is not efficient -- although it is fairly near it, in my view. And because it is not quite perfectly efficient, value shares exist.

I've often told people not to fall in love with shares because they won't love you back. With value shares and selling, the affair is not love but pure lust. A wonderful feeling. You discover something, something beautiful that lies in the gutter. You believe in its inherent qualities but nobody else does. You have no wish to love it but you desire it, want to make it perform for you, for a time. If it performs in line with expectation you will use it then lose it, having satisfied your financial lust. Equally if it does not perform you will heartlessly evict it without a second thought for the good-for-nothing that it is. Ruthlessness is a good quality for a value player.

On the fundamentals, as I've said previously, price to book value (P/BV), if you use that ratio, is usually the first to break. That is, it will go over 1. It breaks first in most cases because the discount to 1 is usually fairly modest to start with. Say for example you bought on a P/BV of 0.9, then the shares need only rise by 11% for the discount to be erased. But if the P/E when you bought was 8 and the yield 5%, then when P/BV hit 1, they would still be at only 8.9 and 4.5% respectively, which remains quite attractive. The net cash of course does not fluctuate with the share price as do P/E, P/BV and yield, and would remain constant until any figures released by the company change it.

I would not sell just because P/BV <1 ceased to exist. But I would probably sell on a strongly rising P/E and falling yield, unless there was indication that perhaps these would come back down to value levels by the release of very good figures by the company. Thus if historical P/E had risen to say 16 and yield to 2.5% and an announcement showed doubled eps and dividend, that immediately puts the shares back on to a P/E of 8 and yield of 5% on a historical basis.

If I do wait for the announcement, at that point I would review the net cash, P/BV and, very important, eps forecasts. If these still made sense I may stay in on the grounds that the share had reinstated deep value status -- in effect, become a new value play after outing its value earlier. This situation is quite rare. To be able to climax twice in succession is a great achievement and will make large profits. But in most cases I find that announcements merely confirm that the share has performed in line with expectations, rather than greatly exceeded them, and has lost super value status. Therefore after a good rise, where most of the deep value has gone, more often than not I will sell shortly before announcements, rather than after, on the grounds that shares frequently fall back following the figures, unless those figures are much better than anticipated. That does not happen often.

The above covers the situation where the share has risen well. But what if it has fallen? As I said with LPG, when it fell initially within a few weeks of my buying, I saw nothing that had changed my opinion so I remained in. But if a share has fallen and there is some reason for this which creates doubt over the value, over the reasons that made me buy it originally, I would get out and take the hit.

For me then, and I understand that people have difficulty with this sometimes, it is fairly black and white. I'm in or I'm out. The share starts with super value. One way or another that value is lost. Mainly by rising rather than something going wrong. When sufficient value is lost, I'm outta there. Can't give you an exact arithmetical point on the ratios, unfortunately, this is one of those things that's down to smell. But as I said, external comment can be a good contrary guide to the odour.

This article was originally published in November 1999. The subsequent performance of LPG speaks for itself.