A reader wrote in to say that he owns way too many junior resource stocks. Many are deep in the red. But when he looks over the list, he remembers why he bought them and can’t bring himself to sell in the face of that potential.
I understand. It hurts to realize a loss. It’s hard to admit we made a bad choice. And hardest of all is to let go of the dream that prompted us to buy in the first place.
But he knows, you know—we all know—we have to. That's why he looks over his list and sighs.
So let’s talk about selling.
I start with the “why” question. If I’m not convinced on this score, the “when” doesn’t matter. And as it happens, answering why also tells us when.
First off, let me say that one size doesn’t fit all. Different folks have different reasons that are perfectly valid for them. Highly risk-averse investors, for example, might be quite right to set stop losses and head for the exits simply on the basis of higher volatility. That would be counterproductive for folks swinging for the bleachers on potential 10-baggers. Nothing has potential for 1,000% gains without being highly volatile.
One thing we can all agree upon is that we have to prune our portfolios from time to time, or they become unmanageable.
We can’t keep real track of too many stories—not without staff dedicated to the task. This is a good reason to adopt an “out with the old, in with the new” policy. Whatever the number of companies we can follow closely, once we reach that number, it makes sense to discipline ourselves to sell our worst stock before we buy a new one. This is the simplest way to maintain a manageable portfolio of stocks we understand well and are highly confident in. And that last point—confidence—is vital when speculating on highly volatile stocks.
But what makes a stock the “worst” one? It’s not just share price…
Here’s a list of specific reasons to sell:
- The company fails to deliver on our basis for speculation. If a company says it’s going to deliver for shareholders by drilling a gold vein discovered on surface, and they drill it but find nothing economic, they failed to deliver on our basis for speculation. We should sell without mercy or hesitation. They may say they have a dozen other geological hypotheses to test, but that’s not why we bought. When a company fails, sell, even if it means realizing a substantial loss. The stock certainly can—and most often will—keep drifting lower after the disappointing news. Worse, even good news after such a failure often fails to revive share prices.
- The company runs out of cash. If this happens while share prices are down, especially if that happens before the company can prove its value-adding thesis, we’re likely looking at the Death of 1,000 Financial Cuts. It’s different if the company has had meaningful success delivering on its promise, but runs short on cash. They will likely be able to raise more money on decent terms. I might even want to buy into that private placement if I like the terms and I’m satisfied with the company’s progress. But if the company hasn’t delivered, the stock is trading for pennies, and they need cash, it’s a very bad situation. Better to get out of harm’s way, and if you really like the people or the project, look to buy back in again when the situation improves—with positive results in hand.
- The venture runs into serious political problems. I know of one company that had villagers burn down the mine camp, but went on to build the mine and deliver a big win for shareholders. Just one. Whether it’s a coup, trouble with guerillas, an adverse ruling from an environmental agency, nationalization, major legal setbacks, a mining ban, or the like, the outcome for shareholders is usually negative for years—if not permanently. Sure, things could turn around, but the odds are vastly against it. Better to just move on. Have a fresh look if and only if the problem is resolved and the company is making good progress again.
- The markets turn against us. As a speculator, sometimes I just get it wrong. We all do. Mind you, I’m not talking about a short-term price fluctuation here. When a trend has clearly turned against a given speculation we’ve made, we risk a great deal if we try to ignore it, or hope the market will do what we think or wish it should. For example, I thought cobalt would head higher last year. I had a good case for this, supported by plenty of data. But instead, cobalt prices started falling. As much as I wanted my thesis to be right, I had to accept the reality of the market. With prices still down this year, I’m sure glad I did. If we want to enjoy our victories, we must also accept our defeats.
- The stock delivers and the value proposition inverts. If a company is being given no value by the market for a great asset, it’s reasonable to buy and speculate that share prices will rise. When the company delivers and becomes a market darling, it may trade for much more than the asset is worth. That makes it very risky to hold. If the stock is on a solid upward trend, I might take profits and ride whatever happens next risk-free. But if the company is objectively overvalued, I’m more likely to put a trailing stop loss on it and take the dough. To convince me to stay long, the company would have to present me with a new value proposition—not the one I originally invested in—and show me good odds for delivering yet again.
Here’s are some that are NOT valid reasons to sell:
- The stock price is lower. Okay, maybe if I were investing in a huge company like Apple, the stock dropping 30% in a day would be a clear sign that something serious is wrong. But for the type of resource stocks I typically invest in, a fluctuation like that could—and often does—happen without anything bad happening to the company at all. For instance, a fund facing redemptions could be forced to sell, even if the company and the stock have been doing great. In my markets, price and value often diverge. A lower price can signal opportunity, rather than a problem.
- Short sellers put out a highly critical “research” report. (The “short and distort” attack against Pretium I debunked last year, for example.) When others profit from us selling, we have to treat everything they say with great skepticism. The same applies to the talking heads in mainstream media; they get paid for exciting headlines, not for making sure that what they say is good advice. Even advice to sell from some well-meaning person who doesn’t understand our market sector should be discounted; they don’t have the full context for an adequate assessment. Bottom line, it’s usually a mistake to sell because others tell us to; we need to come to that conclusion ourselves, for our own good reasons.
- Portfolio rebalancing. This may be fine—or even necessary—for institutions with mandates and other requirements they must meet. Suppose my mandate were to invest 50% in gold and 50% in oil. I might need to sell some positions as they grow in order to maintain that balance. But my mandate is to make money. Some folks may strongly disagree with this, but I think it’s silly to sell a winning stock just because it has become a larger portion of my portfolio.
- Hoped-for wins are taking too long. Patience is a key virtue for successful speculation. Because I’m a newsletter writer, I look for exceptional, near-term wins. My readers love “hockey stick” stock charts—and most don’t like waiting. But as a speculator, I know that a company can do everything right, but the market can still take its own sweet time recognizing that. If the value proposition remains intact and the company is still cashed up and is making good progress, frustration that Mr. Market is slow to love my stock pick as much as I do is not a valid reason for selling. Or more simply: boredom is no reason to sell.
Note that while none of these non-reasons will prompt me to sell, if I have something else I’m very keen on, and I need some cash, I might sell anyway. But that’s to raise funds, not because of the above.
In general, I’m extremely resistant to selling without good reason. I don’t like having to wait more than a year or two for my speculations to work out, but I will if there’s nothing really wrong with my bet.
On the other paw, if I have a good reason to sell, the merciless wolf in me has no qualms about killing to trade.
That’s my take,
