Consider this. If you want to multiply your money 100x in 25 years, you want your investment to return 20% every year.
In other words, Rs 1 growing at 20% per annum will turn to Rs 100 after 25 years, excluding all dividends.
But if you sell this stock after 20 years (instead of holding for 5 more years), you will get just Rs 40. The remaining Rs 60 would come only between the 21st and 25th years.
Even if you earn 15% return per annum, your Rs 1 would turn to around Rs 35 in 25 years. But 50% of these returns would come only between the 21st and 25th years.
That’s how compounding works. The longer you let your money grow, the faster will be the incremental return you would earn.
That’s why selling the great businesses you own is often a wrong thing to do.
This is especially true when you sell such a business because of any such reason –
- This stock has risen “too high”.
- This stock is “fairly valued”.
- This stock is not moving. Others are. (Read what I did with Swaraj Engines)
- Competition is rising.
- New government is bad.
- Economy is going downhill.
- Everything is priced in the stock.
- Let me switch to “something better”
Of course, the possibility that one or all of these reasons may warrant a sale or switch to a better stock should be weighed carefully.
But making a decision with an eye on the stock price or the future potentialities external to the business is (often) a bad idea.
Also, when you own a terrific company, you don’t want to sell simply because it is “fairly valued” today. That’s because the company will continue to grow, and its earnings would be materially higher 10, 15, 20 years down the line.
Josh Billings, an American humorist of the nineteenth century, said…
It ain’t ignorance causes so much trouble; it’s folks knowing so much that ain’t so.
Unfortunately, too many investors have this idea that stock prices react to gravity – if they have been rising, it must mean they are due to fall soon.
But always remember this – As long as the business remains great and you believe in its underlying fundamentals, there is no reason to sell any more than is necessary to rebalance your portfolio.
Finally, remember what Philip Fisher said…
If the job has been done correctly when a common stock is purchased, the time to sell is – almost never.
For every 10X,50X,100X growth story, there are equal no. of value destructors as well. It just take a matter of few months to get a fortune out of our investments. Now….that few months can come once in 5/10/15/20 years. If I find the underlying business is generating profits, leading to the growth of EPS, dividend – I intend to stay invested forever.
3-5 years down the line, if I get 8%-10% return on my initial investment through dividends, my downside is limited and actually protected, that gives me the conviction to stick to the business I invested. Else, I revisit my investing story. I resist as much as possible in not allowing the Stock price fluctuation (high or low or stagnant) influence me.
very insightful indeed. so i wonder with my equity mutual fund , truly claiming to follow Buffet’s value investing , having lowest turn over since inception, maintaining concentrated portfolio of 20-25 shares, having high exit load, but keeping lot of non equity assets up to 30-32% for lot of times. i wonder why they are not choosing to increase the allocation in the held shares instead of switching to non equity, and that too frequently.
Nice insightful article. In the current market many investors may be thinking if they need to sell their stocks, which are great businesses. Its always a good idea to stick to great businesses and keep adding to them when they are available at a discount. There are some stocks which have not gone to insanely high levels, and one can stick with them or add more.
Having said that I also feel that when the valuations go to very high levels its not a bad idea to sell partially. Don’t get me wrong, I’m only recommending a small partial sale to book some profits, which is not a bad idea. That’s what value investors do particularly when they find that the price is way above IV. However, its not a good idea to sell off your entire holdings because there could be some reason for the price to move up which is justified. Either the company has expanded to new markets, or it has some alliance or tie-up with leading players in India or abroad, etc. and these could generate more opportunities for growth. When these things happen you get an opportunity to take a small portion of money home or keep cash for other opportunities. However, the same company could also get cheaper or come at a bargain after a few months or years when the news and wave settles down. If you are someone who doesn’t need the money and think you have other sources of income or cash then my profit booking suggestion may not make sense to you….however, people from middle class background would realize the importance of having some cash and taking profits when its time.
Thanks for your insightful comment, Sridhar!
Hi Vishal,
One tool for all problem is dangerous . Conceptually Compounding is great story , but one needs to work hard to get results .
Composition of DOW right from 1900 to 2000 tells this story . No company can continuously compound its earning for years together . Suddenly one idiot starts running a great company and destroys the company . The key is to be vigilant of how business is working , is it growing profitably if so remain invested otherwise exit . As small time investors we cannot be emotional and hold stocks for 25 years .
Regards
Shailesh
Yes Shailesh, the key is to be vigilant…even for the greatest of businesses.