Selling a big winner is a tricky decision

Portfolio management

Leaving the party early

Today’s post is about the thought process around selling a big winner.

Investors should almost never sell a winner. As Warren Buffett wrote in the Berkshire Hathaway Chairman’s letter for 1988: “… when we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.  We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds.”

So, selling a big winner is like ‘cutting the flowers.’

Selling a big winner

Since selling an entire stock position that has done extraordinarily well is so unusual, I thought it would make a good case study for today’s post.

We can get some simple ideas out of the way. First, one should never set a target price to sell a stock. That will cause you to sell a winner – cut your flowers. Second, if a stock performs really well, there is nothing wrong with selling part of a position from time to time to keep the position size comfortable. Third, selling a stock whose price has gone up a lot because this will confirm how smart you were buying it, is a stupid and counterproductive idea. Fourth and last, if a company is doing well, there is almost never a reason to eliminate the position.  

In the last four years I have eliminated four stocks from our family’s portfolio; two were big winners, one went private and one was a stock that turned out not to be the superb business I thought when I bought it. Here is the post I wrote about the first big winner I sold in this period: Selling a stock – goodbye old friend

This post is about the second big winner I have sold in the last four years.

During this same period, I have added four stocks, all superb companies, bought at bargain prices.

To look at our portfolio as it was in May of 2021 take a look at How I invest my money.

Selling AMAT

Let’s dig into the recent sale of APPLIED MATERIALS INC – AMAT. It was certainly a big winner.

Here is how I described it in my May 2021 post:

“Applied Materials is the leader in materials engineering solutions used to produce virtually every new chip and advanced display in the world. Its expertise in modifying materials at atomic levels and on an industrial scale enables customers to transform possibilities into reality. The current board and executive officers hold about $1 B USD common shares. Market cap $122 B USD; portfolio weight 7.83%; position initiated in the spring of 2020.”

The economic performance of the company since I bought it has been superb. AMAT makes and sells gear that is used to make computer chips, including chips used in Artificial Intelligence (AI). The company makes lots of money and has lots of opportunities to reinvest that money in a growing business. So, lots of reasons to hold onto it.

The price rise of the stock has been remarkable and has paced the world’s excitement about AI. Of course this has been a happy story. See chart below.

The only problem with the stock is that since 2021 it has mostly been overpriced. That is, the stock market price of the stock has been significantly higher than its intrinsic value.

Over the last four years I sold some shares of AMAT to generate cash to live on. Recently it was at about a 9% portfolio weighting and sitting at what I thought was a grossly inflated price.  

Thought process around selling

We can start this discussion with John Templeton’s Maxim 6. “To buy when others are despondently selling and to sell what others are greedily buying requires the greatest fortitude, even while offering the greatest reward.”

He points out that selling when others are greedily buying requires fortitude.

The problem is this. Others were greedily buying AMAT in 2021. I sold a fair chunk of the position at that time but decided to continue to hold a good number of shares. During 2022 and 2023 I was perfectly happy to sit patiently with the position even though it was mostly overpriced. My theory in not selling during that period was to not sell a winner. During 2024 the price continued to advance but it started to move well away from fair value. It got to a point a few weeks ago when AMAT’s price was some 60% above fair value. It struck me that the price reflected serious ‘irrational exuberance’.

There is no hard and fast rule. At a certain point it is wise to bail out. It is similar to the decision I made in 1998 when I sold all our stocks and put our entire family savings into two-year government bonds.

Conclusion

In many ways selling stocks is more difficult than buying them. The surest way to underperformance is to regularly sell the flowers in your portfolio garden. Selling a big winner when it is highly popular and others are greedily buying is a tough decision. Sell too early and you lose wonderful returns. It’s a matter of judgement as to if and when to sell in face of true ‘irrational exuberance’.

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For readers wishing to delve into the psychology around herding, groupthink and the madness of crowds, take a look at:

A set of rules to develop a behavioral edge – Part 4

Also, check out this post that gives a complete set of rules around selling:

19 Cardinal rules on selling stocks

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You can reach me by email at rodney@investingmotherlode.com

I’m also on Twitter @rodneylksmith

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