VALUE INVESTING
Exit Strategies

By Stephen Bland (TMFPyad)
December 16, 2005

A question raised often by newcomers to trading value shares concerns the timing of sales. I've written a number of times on this point in the past but it's an important feature of the strategy so it is probably worth re-visiting occasionally. Let's take a step back and look briefly at the buying decision because that has to come first and is influential in the selling decision.

You buy a value share because it fits a particular set of filters which you consider desirable. Typically these could be low P/E, low Price/Sales, low Price/Cashflow, a good yield, little debt or preferably net cash, trading below tangible assets or whatever rings your bell. Depending on the share you will also have sought an outer, that is, a reason for the share to rise. This could be increasing forecast eps or maybe the share was simply trading so far below undervalued property that sooner or later something was almost certain to be done about this, regardless of eps or dividends. A pure asset play.

In order to make money, the value you saw originally in the share needs to be eroded by the price rising. Sometimes it will be eroded by the fundamentals deteriorating in which case you might lose money if, as is very likely, this affects the price adversely. Either way though, it is upon the erosion of those value fundamentals that the sales decision will depend.

At some stage, sufficient value will have disappeared that you consider it is time to sell. Quite how much remaining value you are prepared to live with and therefore hang on to the share is a matter that will vary between investors. It's difficult to give exact rules here.

Personally, I've always been very cautious about this and have frequently sold too soon by the standards of some players. Too soon because many value shares I've owned have gone on to perform well after I've sold. I've never been tempted though to reconsider my approach as a result because I don't want to hold shares that display inadequate value by my standards. Particularly important if you are holding only one or very few shares as I've frequently done because of the increased risks, though I cannot advocate this policy to others.

So if value shares I've owned have gone on to do well, having gone ex value, or at least ex my kind of value, they've done so not as value plays but had transmogrified into some other kind of share. Let the next guy have that stage of the growth, I believe it to be more risky. If though, sensibly, you hold a decent portfolio of value shares then you can afford to take a few more chances and perhaps water down your definition of how much value you are prepared to live with.

Note that the purchase price should be irrelevant to you as a value player in a sell decision. The idea is not to look at how much profit or loss you are currently making on a share you hold, but how much value remains. I believe that concerning yourself with purchase price and the consequent profit or loss actually makes the sell decision more difficult. That might sound weird to beginners but training yourself to concentrate on the value left in the share and letting that dictate your sell decision is in my view the way to go.

Once it no longer possess enough value, you sell whether a profit or loss results. In practice I appreciate that it is difficult to divorce the purchase cost from the current price in your mind, and of course ultimately you do have to consider it to see how you've done, but that should be secondary, something you do after you've sold. Whilst owning the share, all that should matter to you is whether it still retains sufficient value to call it a hold. Once it doesn't, then sell. Then you can worry about how much you made or lost on it.

When do you start thinking about selling? The moment you bought. You never know when value can out and although it often takes years, it can happen right away on occasion too. The moment you enter the value arena, you keep an eye on the exit and it's marked Deteriorating Value Fundamentals. But don't forget the extreme patience required with this strategy.