[Note to Readers: no companies mentioned by name in the
below blog post are current holdings and there is no intention of advocating
any purchases or sales based on the below commentary.]
In my last blog post, on 30 April 2016, I mused over how to
tread in the event of a bear market in stocks, noting a 49% cash holding in
portfolio-land. This was rather handy in a sense as certain domestic UK stocks fell
markedly eight weeks later following the UK electorate’s vote to leave the EU.
The currency markets voted that this would hurt the island nation’s future
growth prospects, and sterling fell by over 15% from the end of April to the
end of the year.
Mr Market’s reaction to the referendum result was one of
those rare events where certain stocks trade briefly at very silly prices; this
time at bargain valuations rather than what seems a more common
silly-on-the-expensive-side prices that have been more prevalent since the
Financial Crisis. The constraints of my workplace and a broker whose website
was failing and call-centre flooded with incoming orders, meant the first few
hours of trading were blocked for me, but decent valuations persisted for a
number of weeks, leaving time to pick up bargains.
Thus it should have been a return-to-form year for yours
truly, but a few errors were made afterwards (namely selling too soon), and
what now seems like a stroke of bad luck hit the portfolio’s returns in
December to produce another flat year – the second in a row. This time the
result felt extremely poor, with the S+P up 11% for the year (close to 30% in
sterling) and the FTSE 100 up by 18%, the portfolio’s meagre 1% gains looked
feeble in the extreme and ended a run of six calendar years of market-beating
performance.
The bad luck in December was that three of a total of seven
holdings racked up double-digit losses in the same month. Fortunately all three
have since rebounded; less fortunately one was sold before the return to form;
more fortunately one was added to before an over 50% rebound; and happily the
largest holding is now up by almost 100% for 2017 so far. The effect of all
this is that, somewhat related to the calendar year coinciding with temporary
dips in Mr Market’s appraisals for portfolio holdings, the YTD return for 2017
is a rather pleasing +44%.
Now I have been here before, halfway through the year, in a
self-congratulatory mood with over 40% gains, and yet I am still to complete a
calendar year with over 50% gains, which is the benchmark Buffett has pointed
to being a return he ‘knows’ he could generate with $1m or so. So what will come of the full 2017 is a
rather interesting question.
One choice is to lock in gains, riding out the year to meet
that arbitrary hurdle for the first time. Given one of the stocks is what may
politely be termed ‘speculative’ this is of course the prudent course to take.
However, Munger’s concept to constantly search for ‘lollapalooza effects’ and
then maximize the gains after loading up on opportunities exposed to them is
front and centre of why this may be, in fact, a decision that could lead to
regret. On the other hand, the words of Joseph de La Vega that, “Profits on the
exchange are the treasures of goblins. At one time they are carbuncle stones,
then coals, then diamonds, then flint stones then morning dew, then tears,”
spring to mind. Only the passage of time will tell which will be the more apt
given the outcomes for this largest holding in particular are particularly uncertain.
In any case, the concept that ‘nobody ever went broke taking
a profit’, i.e. lock in your gains, fits very poorly with my personal
experiences of selling Lo-Q at an average of £2 per share (having bought in at
an average of £1) to now see it quoted at over £16 per share. I even remember
saying how £6-8 was possible in certain scenarios, and yet the short-term
profits seemed so high relative to my original investment that further gains
didn’t seem likely or even possible, so in the end a conservative valuation for
the business and other factors led me to sell too soon (my last sale was at
£2.40 and there really was no solid reason to sell at the time apart from a 20x
trailing earnings multiple).
More recently I sold my holdings in a UK sports-focused
retailer despite a valuation for the business of almost twice the levels at
which I sold them. I reasoned that they could go lower through earnings. This
worked out poorly as they are up over 20% in the past week (post-earnings), but
as they say – win some, lose some. Another sale that seemed prudent (and even
lucky) at the time was Ferrexpo – sold for an average of 56p/share (despite a
valuation multiples of this higher) and recently changing hands for over
£2/share. Holding stocks of a lower quality, it seems, requires something of a
stomach for short-term declines in quoted market prices. The gut truly is a
more important organ than the brain at such times, and sticking to a process
and maintaining a logical appraisal of a firm’s prospects and fair values for the
potential outcomes matters more than the instinctive response to either gather
more information to understand the odds of future outcomes better (hint: it
rarely helps) or to cut the position to stem the feelings of pain that losses
can induce.
Conversely, it certainly seems wise to sell when a stock has
done well on the back of limited new information, i.e. merely a change in the
mood of Mr Market vs a clear change in the underlying fundamentals, and yet
this could mean walking away from large future potential profits should the
business have future outcomes not fully discounted at the time the decision is
made. Note, however, it is the prospects of the business that require
appraisal, not that of the share price. The former is important and elements
will be knowable, whilst the latter is a blend of a scoreboard for the business
and the mood swings of an ever manic-depressive business partner, known as Mr
Market.
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