Buffett Never Sells, Should You?
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
How Berkshire Hathaway Got Bigger by Getting Better (Part Eight)
As we continue on our study of one of the greatest investors and wealth creators our country has ever known, Warren Buffett, the insights gained should enable investors to become better and thereby grow their portfolio bigger. His “Owner’s Manual” for Berkshire Hathaway (NYSE: BRK-B) shareholders is an exceptional case study in discovering how to view your own portfolio. I’ve been looking at each principle laid out in the owner’s manual from the perspective found in a story inspired by Chick-fil-A founder Truett Cathy. If you haven’t heard the story yet, back in the 1980’s when a Boston Chicken (now Boston Market) had just finished raising capital to expand; the management at Chick-fil-A spent a long time discussing how they too could get bigger in order to fend off this threat. After hearing enough talk about getting bigger, Cathy pounded the table and said, “I am sick and tired of listening to you talk about how we can get bigger. If we get better, our customers will demand we get bigger.” As we head into the eighth part of this series, we’ll learn how Buffett handles the investor’s conundrum: when to sell.
“You should be fully aware of one attitude Charlie and I share that hurts our financial performance: Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns. We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations. We hope not to repeat the capital-allocation mistakes that led us into such sub-par businesses. And we react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures. (The projections will be dazzling and the advocates sincere, but, in the end, major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand.) Nevertheless, gin rummy managerial behavior (discard your least promising business at each turn) is not our style. We would rather have our overall results penalized a bit than engage in that kind of behavior.”
Ok, so maybe for Buffett it is not much of a conundrum as he never sells. Winner or loser, it doesn’t matter because Buffett isn’t going to make a move (though to be fair he's referring to businesses owned by Berkshire, not stocks in the investment portfolio). Yet, if you are like most investors after a stock’s made a big move in either direction you typically will react with one of the two basic human responses: fight or flight. Not so with Buffett, he won’t take up a fighting position by doubling down, nor will he flee the position by dumping it at whatever price the market’s offering.
Kind of makes you feel embarrassed doesn’t it. How many times have you doubled down (or up) on a position after a big move only to regret it later on? Vice versa, how often have you dumped a stock after a big move only to see it move again? Let’s face it though, sometimes we’re playing in the deep end of the pool and a sale is probably the best course of action for our situation given the risk. However, for Buffett who’s focused on value and cash generation he works diligently at buying better so that he doesn’t ever have to sell.
So where does that leave the average investor who wants their portfolio to grow bigger? Focus on the buy and the sell should never come into play. Make sure the position fits into your portfolio both strategically and rationally. It’s really hard to go wrong buying companies with safe, secure and growing dividends. It’s when you go all in for growth that investors get into trouble.
Tech companies are famous for overpaying for growth that just doesn’t quite fit well in their portfolio of businesses. When that growth doesn’t materialize, they’ll jettison the business paying no mind to the shareholder capital squandered along the way.
Take a look at eBay’s (NASDAQ: EBAY) original acquisition of Skype for $3.1 billion. Investors were left scratching their head when the company announced they were adding another leg to their stool in the form of communications to go with marketplaces and payments. After writing down much of the original investment, eBay caught a break and sold two-thirds of the company to Private Equity for $1.9 billion. Or they thought they were catching a break, as the PE firm then flipped the company to Microsoft (NASDAQ: MSFT) for $8.5 billion. If they hadn’t overpaid for the platform that was hardly profitable, they’d be less inclined to sell later on as the company’s value began to be realized. Instead of selling to Microsoft the company could have simply licensed the technology and enjoyed the recurring income for years to come.
Patience is one of the key traits of a successful investor. Have patience to sell correctly and you will invest with much less regret. Here are three reasons that I think warrant you consider whether a sale is in order:
- If you have a better place for your money – While many would promote the efficient market theory, in reality market disconnects do happen. When you find one, selling a fairly valued stable company and replacing it with an undervalued company can improve returns.
- If the stock has grown to become an uncomfortably large part of your portfolio – Each investor will have their own “uncomfortable” number but when a company has grown to be 15% to 20% of your portfolio it’s probably a good idea to sell some of it.
- If your original thesis is broken beyond repair – Probably the most difficult to determine, but if the company is in permanent decline look to sell. What’s permanent decline? Balance sheets bloated with debt and mounting losses is one place to start.
Buffett's made some notable investment sales over the years. Recently, he sold shares of both Moody's (NYSE: MCO) and ExxonMobil (NYSE: XOM). While each move by Buffett is diagnosed in detail, we really don't know why each move was made. Some would say he sold Exxon because they used their undervalued stock to buy XTO Energy in a move Buffett didn't like while others would say he's dumping Moody's because they downgraded Berkshire's AAA rating. No matter what the reason, the bottom line for Berkshire was they simply had a better place for the money that was invested in each company, whether that was funding their acquisition of Burlington Northern or another portfolio addition.
Still, the best course of action is to buy great companies at good prices and hold on to them forever. When you sell a stock you’ll incur commission charges and taxes which end up eating into returns over time. If you really want your portfolio to get bigger, follow Warren Buffett’s advice on how to invest better. Become a long term owner in the underlying business, not a short term trader of ticker symbols on the computer screen.
latimerburned has no positions in the stocks mentioned above. The Motley Fool owns shares of Berkshire Hathaway, eBay, Moody's, Microsoft, and ExxonMobil. Motley Fool newsletter services recommend Berkshire Hathaway, eBay, Microsoft, and Moody's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.