June 11, 2024

Investing Is About The Future. Look Forward, Not Back.

The investing world is in no shortage of silly little axioms intended to eliminate nuance in the investor's mind. Wall Street has no problem feeding the masses faulty heuristics on the regular.

They'll rattle off platitudes such as: sell half when it doubles and play with house money.

Never catch a falling knife.

Don't fight the tape.

And let's not forget the dreaded: buy the rumor, sell the news.

The reality is that these tired, overused sayings are a disservice to the individual investor, encouraging them to trade when they should be investing. By zooming out and lengthening one's time horizon, investors vastly increase the odds of making money and outperforming the S&P 500 and greater stock market.

Today, let's briefly examine the first of these expressions: selling half when it doubles.

The underlying sentiment of this statement reeks of selling for the sake of selling and locking in investment gains out of fearful emotions, as opposed to selling for the right reasons: 

  1. The money is needed for personal reasons, and the stock must be sold to create cash.
  2. The investment thesis is broken and the portfolio position can no longer be justified, meriting a trim or sell.
  3. The investor has found something clearly superior to buy (opportunity cost). This one is tricky, use it sparingly.
  4. The position has grown to an exceptionally large weighting and trims for risk management purposes come into play.

An asset is worth the present value of all future cash flows.

Ultimately, investors need to focus not on what the stock has done, but what the stock will do.  The only way to do this is to keep one's eyes on the road. To ruthlessly evaluate forward returns without anchoring too much to the past. To know what one owns and why, while recognizing that businesses, industries, and sector dynamics can change quite drastically and what once looked like an incredible opportunity can turn into a value trap.

  • A pharmaceutical company with patented products may be a wonderful investment, but are likely to be considerably less so once their products go off-patent.
  • Similarly, an oil producer will do incredibly well during boom-time pricing of $110/share, but if more producers enter the market (thereby increasing supply), oil prices will drop significantly and the investment opportunity in such an oil producer will become less compelling.
  • A payments company can be wildly cash-flow positive, but should take rates decline on payments volume, unit economics and profits will deteriorate over time, and the stock will be more expensive than its trailing multiple is indicative of.

While selling half when a stock doubles may sound good in theory, the merits of this approach are dubious at best. Focusing on each investment for its merits will allow investors to better capture the right tail and avoid value traps; with a more accurate framing of free cash flow per share, the growth and defensibility thereof, investors can know what they own, capture more right tail outcomes, and earn healthier returns in their portfolio.

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