How should stocks be sold during a slump?

Recently, the collective sell-off of holding group stocks has taught many people a lesson. Watching the account’s floating profit shrink day by day, investors pounded their chests and regretted not being able to sell earlier; every subsequent rebound made investors torment, wondering whether they should sell decisively.

There is a saying in the stock market, "Apprentices are the ones who buy, and the masters are the ones who sell." The implication is that the selling point is more test of the investment level than the buying point. How should the stock be sold? Different investors follow different trading systems. In this article, we focus on the selling philosophy of value investors.

Two types of value investors

In the stock market, value investors are an important school of thought. They generally agree with the following investment concepts: "Buying a stock is buying a company", "pursuing the margin of safety when buying", "Mr. Market's quotations are capricious, but in the long run, the price will move towards value. Return", "Only trade within the circle of competence".

There are two sources of income from value investment, one is the income generated by buying at a low price and the price returns to value; the other is the income generated by the sustainable development of the enterprise itself. Around these two sources, in the decades-long practice, value investors have gradually differentiated into two major schools:

One is represented by Graham, who buys when it is undervalued and sells when the value returns to earn the valuation difference; the other is represented by Buffett and Munger, which emphasizes buying excellent companies at reasonable prices and holding them for a long time. , make growth money.

In the short term, the return of price to value can produce good returns; but if you look further, the long-term sustainable growth of outstanding companies is the bulk of the income and the most fundamental source of value in stock investment. It is in this sense that Buffett learnt from Graham, but he has achieved better than blue.

Back to the issue of selling points, value investors represented by Graham will sell when the price returns to value, which means that once it is overvalued, it must be sold; while value investors represented by Buffett, They are more willing to accompany outstanding companies for long-distance running, and pay more attention to whether the fundamentals of the company have changed. Generally, they will not sell due to overvaluation.

Li Lu, the founder of Himalaya Capital, was called "China's Buffett" by Munger. In a speech at Columbia University, Li Lu was asked when to sell, and he answered this way:

I used to have a rule that if at a certain price I wasn't going to buy, I could sell. Now (2006) I feel like I've evolved a little bit because when I get insights into a field, a company, I really feel like I'm the owner of the business. Even if someone says, you should sell, the price is already high, and I really don't want to buy at this price, but in the long run, my insight and deep understanding of this company and this industry tell me, The chances of winning are still great. ...At this point, you won't want to sell at all.

Therefore, according to Li Lu, as long as you are really optimistic, even if the price is too high to be worth buying, you will not want to sell it at all.

Too expensive to buy, why not sell it?

After a closer look, this answer seems like a paradox: since it is admitted that the price is expensive and not worth buying, it is a rational choice to sell at a high price, so why not sell it?

Taking Moutai as an example, if an investor bought it two years ago, and the book has a relatively large floating profit, at the beginning of 2021, facing a price-earnings ratio of 60 times, the upward space will be blocked in the short term, and the downside risk is very high. At this time, rational investors are unwilling to buy at high prices, shouldn't they sell to take profit?

Many investors struggle with this, especially when they see the share price fall and the floating profit continue to be diluted. On this issue, you cannot simply copy homework. To learn from the answers of others, you must know what is and why, and finally make an independent decision based on your own situation.

Li Lu's reluctance to sell is mainly due to three reasons: First, he is worried about selling flying. If the stock price continues to be at a high level after selling, or even getting higher and higher, it is very likely that there will be no good opportunity to get on the bus again. The second is the issue of tax savings. In the U.S. stock market, capital gains tax ranging from 15% to 20% is payable on the money earned from stock trading. After selling, it is taxed for floating profits, so it cannot enjoy the tax saving effect. The third is to focus on long-term investment. As long as the long-term development prospects are good, there is no need to care about short-term gains and losses.

Zhang Kexin, founder of Gray Assets who also believes in value investing, once said:

Many domestic value investors have unsatisfactory investment returns. A very important reason is that value investment machinery is understood as long-term holding and not selling. But just imagine, what is the purpose of holding when the stock price is already significantly higher than its intrinsic value? Is it waiting for the stock price to fall to find value?

Speaking of it now, the standard answer is about to come out: For stocks that are optimistic for a long time, overvaluation is not a reason to sell, but when they are crazy overvalued, they should be firmly sold.

The answer seems to come out, but there is a new question, what is crazy overestimation?

What is the standard of crazy overestimation?

Stock valuation is the discount of future cash flow. It is necessary to estimate the future profitability of the company, and also need to consider the level of the discount rate, which is inevitably subjective. This also determines that there is no accurate valuation at all. It's just an approximation, what Buffett calls "vaguely right."

The mainstream valuation methods include price-earnings ratio PE, price-book ratio PB, price-sales ratio PS, discounted cash flow model DCF, segment valuation and other valuation models. Each valuation method has its own advantages and disadvantages and is suitable for different types of valuation models. Different stages of development of businesses and businesses.

For example, the price-earnings ratio (PE) is the most mainstream valuation indicator and is suitable for companies with positive earnings and relatively stable earnings;

For asset-heavy industries, there is a large amount of depreciation and amortization, and current profits cannot represent future profits, and the PB valuation method is more suitable for price-to-book ratio; for cyclical industries, earnings fluctuate greatly, and the price-to-earnings ratio indicator is easily misleading. is a better indicator;

For companies whose cash flow is easy and accurate to predict, such as innovative drug companies, the market often uses a cash flow discount model for valuation.

In this sense, the price-to-earnings ratio and the price-to-book ratio are not absolute criteria for judging the valuation. Similar to growth-stage technology companies, unprofitable Internet companies, etc., the price-earnings ratio is usually very high or even negative, but it cannot be based on this. Come to the conclusion that the stock is seriously overvalued.

Investors can rely more on historical valuation levels to draw a relatively vague conclusion. For example, the historical price-earnings ratio of a stock is in the range of 15-50 times. When the price-earnings ratio is close to 50 times, it is in a state of overvaluation. If it reaches 70 times, it may be regarded as seriously overvalued, and you can consider selling.

This operation may also make mistakes. Once you make a mistake, you can bear it. There is no 100% winning rate in investment.

What to buy after selling?

In the view of many value investors, holding cash is unwise, and investors must think about what to buy before selling. For example, Li Lu mentioned three criteria for selling stocks. The first is to buy the wrong stock, the second is to go up too far, and the third is to exchange for a better target, namely:

“As an investment manager, your job is to continually improve your portfolio. You start with a high bar and keep raising that bar. The way to do that is by continually finding better investment opportunities and continually optimizing the opportunity cost. . These are the three possibilities I would sell."

What to buy is beyond the scope of this article. But given that most investors will instinctively switch to stocks with low price-earnings ratios, here are a few undervaluation traps that remind you of what not to buy.

One is that the winner takes all the non-leading players in the industry. As the name suggests, in a winner-take-all industry, only winners have investment value. Non-leading players cannot become winners, and their viability is worrying. No matter how cheap the valuation is, they cannot be bought.

The second is the non-head enterprises in the sunset industry. In the sunset industry, the industry lacks room for growth, and the survival of the fittest is accelerated internally. The survival space of non-leading companies has been greatly reduced, and no matter how cheap the valuation is, it cannot be bought.

The third is cyclical stocks that have passed the peak of the cycle. For example, brokerage stocks at the high point of the bull market and pig stocks at the high point of pig prices, at the high point of the boom, their profitability increased significantly, resulting in a very low price-to-earnings ratio, which looks very cheap, but the industry is about to enter a decline. At this stage, the profitability of the company is rapidly shrinking. Buying at this time is easy to be stuck at a high level.

The right way for ordinary investors to invest

It is not difficult to see that selling is a knowledge, and replacing and buying after selling is a knowledge that requires some insight and decision, which is a medium-to-high difficulty action. For ordinary investors, "selling skills" are not easy to master, but they are easy to get out of shape-the original intention is value investment, but in fact they have become speculative players who trade frequently.

What is a better way? Highly dispersed + long-term holding, as Buffett said,

I think 98% to 99% of investors should be highly diversified but not frequently traded, and their investments should be similar to very low cost index funds. For ordinary investors, this investment is the right way.

Because of the high degree of dispersion, there is no need to care about the overvaluation of individual stocks, and there is no problem of selling and buying. As the stock god said, this is the right way for ordinary investors to invest.

Suning Financial Research Institute