Know when to hold ‘em and when to fold ‘em

Knowing when, if ever, to sell a high performing stock is a difficult decision. The turnover of stocks in the International Shares Fund portfolio over the last 12 months has been extremely high relative to history. That's improved returns for our investors this volatile year. But we're happy to hold stocks for the long run when the equation makes sense. We've held Blancco, Zebra Technologies and Motorpoint for some years. We’ve written quite a lengthy piece in our quarterly report about some of the things we have historically gotten wrong and mistakes that people are making more generally.

I still own a few stocks directly that I've held prior to working in funds management, some stretching back decades. ARB Corporation (ASX: ARB) is one I've held since 2001, it's gone up more than 20-times also paid lots of dividends and special dividends. It’s been a great case study in the power of compounding, and the value of that interest-free loan from the taxman (in terms of delaying capital gains tax) if you back the right company.

I could sell up now and pay capital gains tax on the bulk of the proceeds before reinvesting elsewhere, or I can leave the greater amount of money under the steerage of the Brown Brothers (presumably no relation, although perhaps I should check). They've done a great job over the last few decades and hopefully have a few more years in them yet.

A good problem

One of the things we’ve "struggled" with in the International Shares Fund over the past year is stocks shooting up faster than we expected. With ARB there was a 20-fold return over a couple of decades. We have had stocks in the portfolio that are up five- and ten-fold in the space of 12 months, that's a tougher problem. One of the easier things about ARB has been the business has compounded along with the share price over time. It helped that ARB's share price rarely got too far ahead of itself. 

Charlie Munger says something along the lines of “It’s hard to pay too high a price for a wonderful business”. That applies here and it particularly applies to non-promotional management teams that don’t tend to let their stocks run too hot. 

The shares might have grown a little faster than justified maybe three or four times over the last few decades. But they’ve always grown out of that problem relatively quickly and easily. There’s probably been a couple of occasions where I might have done a little better if I sold and moved the money elsewhere. Or perhaps not. It’s worked well enough so far.

We’ve tried to incorporate more of that thinking into our portfolio over the past couple of years, We won't be loyal to a fault, rather we aim for being loyal where it pays. We’ve got some wonderful businesses in the portfolio. Blancco, we’ve owned now for quite a few years, has grown into its valuation at each step along the way, a small-cap with a growing moat. Zebra, Motorpoint and a few others have got everything in place to hold them for a number of years if the valuation doesn’t get too far ahead of itself. 

Turnover has been unusually high this year because of volatility. We’ve been buying stocks at deep discounts to our estimate of intrinsic value. Those gaps have often closed in a matter of months or even weeks. That's when portfolio turnover pays. The other part of it here is the opportunity set. One investment might have rocketed, but we’ve found other places to put money to work. The idea here is to always try and earn the best risk-adjusted returns. Investors should expect us to do more selling and buying in an environment like 2020 and early 2021, it’s been optimal to turn the portfolio over much more than usual. The market won't always work like that though.

The takeaway

The main lesson out of all of this is that the value of a business is not a static thing. A common mistake made is the assumption that because the share price is up, I need to sell. 

You’ll first want to ask yourself a question: Was my estimate of the value of this business right when we first bought the stock? What’s changed since then, and how much do I think it is worth today? 

And constantly be thinking of the value itself as something that’s dynamic, where you’re constantly trying to update it and get it right for what’s in front of you rather than what’s behind you.

But it is also important to recognise the immense power of good management, a strong competitive position and the value of the intangible elements of some businesses. There are certain investments you want to give much more leeway to than others.
Hopefully, you’ll see some of those high-quality businesses stay in our portfolio for a very long time, with our wealth growing alongside the value of those companies.

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Gareth Brown
Portfolio Manager

Gareth Brown is a Portfolio Manager at Forager Funds Management, with a focus on researching European stocks for the Forager International Shares Fund.

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