Selling some few hours prior to a neat 20% rally sucks (See the RCI Hospitality chart below). I guess we´ve all been there and we cannot undo our decisions. What we can do is trying to avoid similar unnecessary letdowns in the future.
To do this I will try to put down some principles that might keep me from hastily hitting the sell button. I am aware that hindsight often makes situations appear very clear, which at time of the decision were highly obscure. However, I firmly believe that by following the five straightforward rules below we can avoid RICK-like selling decisions and enable us to fully realise upside potential.
- Sleep Over the Decision
Never execute the actual sell on the same day the selling decision is made. Every decision is connected to emotions. Otherwise us humans would not be able to decide at all. Same goes for the decision of selling a stock. A whole bunch of emotions coming from e.g. the reaction on a just released negative analyst commentary or even the own mood because of todays weather, channel into the selling decision along with the actual facts. Biased actions are the consequence. A good nights sleep sometimes breaks this emotional tie and lets you separate the noise from the signal.
- Revisit the Initial Thesis
In this sense it helps to have on storage some key facts and a simple model on why a company´s stock was bought and what the approximate intrinsic value (conservatively calculated) is. Revisiting notes helps to recall arguments in favor of the investment and makes it possible to assess whether or not new information changes the situation materially. If not, stick to the original price target.
- Update the Model to Incorporate News
If there is relevant news out there it should of course not be left ignored and quick update of the model might help. E.g. in the RCI Hospitality case I should have simply reduced the calculated intrinsic value by the present value of an eventual lawsuit factored by the probability of occurrence of the same. Had I done so prior to selling I would have seen that even a USD 20 mn class action with a high probability of occurance of 50% would have reduced the value of the investment from USD 16 to USD 15 at max. Hardly a reason to sell. Naturally if the so calculated updated intrinsic value produces a price target that is below or very near the current valuation selling makes sense (but only on the next day!).
- The Time is on Our Side
Don´t take all bearish arguments at face value, especially when we are dealing with other people´s opinions rather than hard facts. If there is sufficient margin of safety in the price there is plenty of time to do research and make a picture of the situation for yourself without having to fear a permanent loss of capital.
- Proper Due Diligence Equals Robustness
The better the due diligence the better the understanding of a company the higher the confidence in the own thesis. Nothing is more damaging then having an incomplete or only vague understanding of a company. Know What You Own is the go to solution. News from whatever channel can be borne easily when we know what to make of it and how it affects the intrinsic value of the company of choice. Contrarily, when having only little insight into the investment the constant flow of news will wear us out and will push for very frequent, value-destroying buy and sell decisions.
All in all some principles are quite easy to follow through while others require a little more effort from the investor. A famous saying applies “if it was easy everyone could do it”. And on that Bombshell… just kidding watched too much TopGear as of late.
The returns will appreciate the troubles.