I am currently holding an investment that has risen 105% since my first purchase in November 2015 and 171% since my second purchase in January 2016. This is a good problem to have, but to maximise this investment I still need to work out whether it’s time to sell or if I continue to ride it out?
In Part 1 of the, ‘Working out When to Sell a Share Market Investment,’ series of articles I am going to start with the topic of defining the type of investment and how this affects the way I value an investment and decide on my sell price. As a value investor it always comes down to determining, ‘Price vs Value,’ but for each style of investment determining that value is a different art.
What style of investment is it?
First I need to be clear what style of investment it is. If you continue to follow along with my investing story you will see this next paragraph all of the time. The reason for this is that the style of investment I have made determines the buy, hold and sell decision making process. Confusing the three can be costly.
During my research and screening processes I look for three different styles of potential share market investment opportunities:
- Great companies at a fair to discounted price to my valuation.
- Cyclical companies at a large discount to my valuation.
- Asset Plays – Companies trading at a large discount to my valuation of their net tangible assets.
All three styles are based on a value investing framework and my goal is the same for each: ‘To produce a long term compounding annual growth rate over 15% (preferably 20%).’
My Preferred Investment Style
Hands down I would rather purely hold 8-12 great companies in each of my portfolios and hold them each forever. Great companies when picked well and bought at the right price tend to do much of the work for you, churning out profits for years. COH is an example of this from my Historical Portfolio.
Problem with great companies however is they don’t go on sale all that frequently, so there a fewer buying opportunities, and I don’t really like to have too much ‘lazy cash’ sitting around in a cash account when I could potentially put it to work. So, I also look out for Cyclical Investments and Asset Plays.
Next, in my line of preference is cyclical companies. Companies in cyclical industries can still be really good companies and on top of that during cyclical downturns share market participants tend to get really pessimistic on their future prospects, sometimes pricing cyclical companies as if the industry is coming to a complete end. FLT and PTM are examples of cyclical investments in my Historical Portfolio.
Asset plays are the lowest on my list, but they do have a tendency to be the most fast-paced and exciting investment. Asset plays are more often than not lower quality companies, often without an income stream, smaller in size, there are more unknowns and you have to keep your eye more focused on the ball. RHG and IGR are examples of asset plays that went well and TIM is an example of what can happen if you get lazy in your asset play research from my Historical Portfolio.
Essentially, a great company should keep churning out large profits well into the future, potentially for 7 years or more. A cyclical company as the name suggests should do well over a specific cycle of approximately 3-7 years, but will require you to keep an eye on the cycle and price more closely, and an asset play will be an investment you need to keep a close eye on and usually sell within 1-3 years once the market has realised it’s value or not.
A Spanner in the Works
Just to confuse things, an investment in a company can begin as one style of investment and then turn into another if the company or scenario transforms itself. For example, the specific investment I have mentioned in the introduction was bought as an asset play, but the investment is beginning to turn itself into a potential cyclical investment.
Originally I bought into the company, which was not producing much profit at the time, as I believed the assets it held were of a greater value (40% or more in my opinion) than share market participants were valuing the whole company at – hence why it’s called an asset play when you buy into an investment at a discount to it’s assets. Now however, the company has reigned it’s costs in, improved it’s management structure, paid off it’s debts and is producing increasing amounts of free cash flow. As this holding is in the cyclical mining industry and has managed to perform relatively well during tougher times, I am considering continuing to hold this investment now as a cyclical investment.
Note: I am classing this investment as a ‘cyclical investment’ and not a ‘great company’ as I personally don’t believe mining companies are great companies, however they can produce strong returns through a cycle.
Next Article – Part 2
In the next article I am going to start from the bottom up and note how I approach valuing an Asset Play and when I consider selling it. As you may have guess, Part 3 and then Part 4 will follow and be about valuing and selling Cyclical Investments and then Great Companies.
Enjoy the ride!