When to Sell a Stock Exactly for the Buy and Hold Investor – Warren Buffett Style of Investing


Hi I’m Jimmy in this video we’re looking at a great way to know when to sell a stock for buy and hold investors. And the best part about this investment approach is that it allows for us to avoid the noise in a stock much easier than we may think. So for this video I’m going to use a real stock from a few years back and I’m going to show you how I use this particular investing method and then I’ll show you some potential changes we can make to it. Now in the name of full disclosure this investing approach is actually mine. I took it from guys like Warren Buffett or Charlie Munger or Peter Lynch. All I did was took what they were preaching and I put into Excel and I came up with a good way to try to follow an investment without being bothered by the noise. OK onto our Microsoft example. This is a real example of my analysis of Microsoft back in 2016 for a friend’s retirement account. So it was intended to be a long term investment. And that’s really important to this whole investment approach. It really only works if we’re intending to hold the stock for at least a couple of years. Now this is a classic buy and hold Warren Buffett style of investing. OK let’s get started. So the year is 2016 and the third quarter just ended. And here’s what Microsoft’s chart looked like at that time. Now this drop right here. Well this happened because Microsoft came out with earnings and analysts were expecting 64 cents in profit. And in the actual number that was reported was 54 cents. Then we started seeing headlines like this earnings decline accounting methods blamed. And profits fall by 25 percent. And in the month after the earnings were announced this is what the chart looked like. That’s where the earnings were actually reported. And what was interesting about all of the news that was coming out about earnings was that pretty much all the headlines said that earnings were down big revenues were down to flat. But everything was pretty much a variation of that. But if we dug deeper will Microsoft executives were coming right out and saying this is the wrong way of looking at it. In fact one Microsoft executive said that on a gap basis revenues were down 6 percent but when they adjusted for Windows 10 deferrals they actually grew by 2 percent. And if you adjusted for the currency Well it grew by 5 percent. Now I bring this up because I think it’s important that each of us let our research stand on its own ignoring mostly outside information. And just because everybody else is screaming that earnings miss or revenue miss or whatever it might be we don’t let that affect our stance as long as we look closely at the actual information. OK so this brings us to when we actually buy the stock so we jump in we buy 100 shares of Microsoft at about fifty one dollars per share but before we do that we come up with this. This is the table that we create and here I included 2014 and 2015 for historical reference for the sake of the video. But really what we’re after. In my mind is the projections. Here we throw up the next five years of projections and at that time I just took analyst estimates and basically what we cared about was analyst estimates for revenue for the next five years and then net income margins I’d put in there what they were expected to be. Now this is important at the time because this is how I was calculating my fair value of the stock. And at the time I was calculating the fair value to be about seventy seventy five dollars a share. But ultimately by including net income margins and revenue projections because stock prices tend to be highly correlated to both the margins of the company the profits of the company and growth of the company. So at this point 2016 when we buy the stock the first three quarters of 2016 were already completed. Well as time goes by another earnings number comes out and this is what the chart looks like from the day we bought this stock up until the next earnings announcement. So yes we’re up and it’s been a bit volatile but do we want to sell the stock now. Well clearly the answer is No. So I’m only gonna show two more charts from Microsoft stock going forward. Basically we’re gonna focus right here because at the end of the day this is the most important thing. If we did nothing else but watch this table I think we would do perfectly fine. So we had our first three quarters already filled in and once we got the new earnings from Microsoft Well we filled in both the revenue numbers and the margin numbers. And at that point we can see that revenue missed by about 400 million dollars and margins came up by 2 percent short while we’re in this for the long haul so no worries just yet. So time begins to pass and we spend very little time checking Microsoft’s actual stock price. The only exception for that would be as if we’re looking to put more money to work for looking to buy additional shares. But let’s pretend we’re not. So we barely have to worry about what Microsoft stock is actually doing now in practice actually check the news in the stock price about once a week just so I can stay on phone with the company. So if the. He has a big move. Well it’s likely to be tied to news and that allows for me to challenge my investment thesis which by the way at that time investment thesis for Microsoft was focused on Microsoft’s recent shift from paying outright for Office or Windows to more of an annual subscription base. Plus they had recently come out with their surface products and I was a huge fan of them at that time. I thought that was a perfect fit for their business model. But either way let’s pause right here now. This is after the first quarter of Microsoft’s 2019 number. Now Microsoft has their year end at the end on June 30th of every year so the first quarter is actually end of September of 2018. Now this is important because this is what the chart looks like from the day we bought the stock till Christmas Eve of 2018. And as you may remember December was a pretty rough month for the US markets back in 2018. Well how do we feel about Microsoft stock now. We bought the stock down here at fifty one dollars a share it climbed as high as one hundred and fifteen dollars and since then it’s down almost 20 percent. I’d hate to see this thing keep falling. Do we take profits or do we want to stick in this thing for the long run. Picture the emotion that we’re feeling as we’re watching all of our profits roll away. Well this is where I think it’s important for us to remember that this is the wrong thing for us to be looking at. This can trigger very interesting emotions when we’re investing. Instead let’s go back to our handy dandy spreadsheet now. This one is what we want to focus on. Now if we look at this revenue in 2016 missed by about 400 million dollars and the margins missed by about 2 percent. Don’t forget we want to compare margins to our margin projections. That’s where I get that 2 percent from then in 2017. The mix was even bigger. And when we jump over to 2018. Well things started shifting in our favor. Revenue actually beat expectations our expectations by six point five billion dollars and margins saw a small uptick although they’re not at our 26 percent price target margin target just yet. Now in 2019 we saw that momentum continue. When we look at each of the quarters relative to each other. Well things look pretty good. Now this is true for each quarter. So to me this is a sign of a solid business. And it’s actually why I’d like to lay out this spreadsheet like this. I want all the quarters to be horizontal so we can compare them to each other because if you compare quarter to quarter Q1 from year to year pretty good growth. Q2 good growth Q3 Q4. Same thing. But if we to look at them horizontally like this well we might not realize that the dip in Q3 is a natural dip from year to year. It could look a bit more volatile when we go straight down from Q1 down to Q4. Now this brings us to today and ultimately the real question is when do we sell a stock. Well as buy and hold investors I think it’s key for us not to be trying to gear up to sell a stock too quickly. I believe that the most appropriate time to sell any stock for a buy and hold investor is when we find out that the reason we bought this stock is no longer in play and our outlook changes in a meaningful way. Often we can see that in the numbers perhaps its margins perhaps its quarterly revenue growth year over year or annual revenue growth year over year. Perhaps the reason in this example I believed that Microsoft switched to the subscription model would generate more revenue as management was saying it was let’s pretend that’s not materializing. Perhaps getting out is a solid move but it is a move based on the fundamentals of the company are exiting the position be based on the fundamentals of the company and not what the stock price is doing. Now another good reason to potentially sell a stock is that if we have a better investment opportunity somewhere else. So I’ve heard a few people say that you don’t really lose until you actually sell the stock. And I saw this a lot around General Electric over the past few years as we saw the stock price tumbling. And while yes this is true from a tax perspective there is also something to be said for opportunity cost. See had we sold out a jeep back in this area well even if we took a loss if we’re putting that money into an investment with a better opportunity that we believe has better long term prospects that could also be a great move. Now with the example of GE. GE. pretend that the reason we got involved with General Electric was because we believe that General Electric’s biopharma business was going to be the thing that drove them forward and then they go ahead and they sell their biopharma business. I recognize it into that later but let’s just imagine if they had gone and sold that and that was the reason we got involved no matter what the stock price has done we should reconsider that investment. Now perhaps they replace that with a better opportunity and that might be a good reason to stay. But in my mind that is what we’re looking for a shift. Our investment thesis or the fact that the numbers aren’t materializing as we expected. So the real answer for when to sell a stock is we only want to sell that stock. If our long term outlook for the company changes for the worse. So watching revenues or profit margins or free cash flow or dividends per share are a good way to gauge whether or not our plan is working. Now I also like to generally read management’s press releases after earnings calls or their management discussion and analysis from either their quarterly filings or annual filings. I think usually there they do a pretty good job of discussing the plan but only if this stuff changes in a material way. Is it worth getting out of a stock if we’re in it for the high dividends and the company suddenly cuts the dividend even by a minimal amount. Well that might be worth reconsidering if this investment is going to be good over the long run but if we stick with a table like this and this becomes our compass to guide all future investment decisions around this particular investment well we can also update this table whenever we want and we can put in new numbers we can extend them out further for future years if we let this information guide us then the day to day noise of the stock price can often be washed out by the overall trend of the business. So in the case of Microsoft. Well when are we going to sell the stock. The answer is really not now. It depends on what happens in the future. On December 24th of 2018 we saw the stock crash or a stock pullback pretty big. I was perfectly happy just sitting there it didn’t bother me at all because you and I know the overall trend of the business. We know it’s going very well. Don’t worry about what the stock is doing and I’m happy to sit here for the next 20 years holding Microsoft if their business continues to perform. So my question to you is do you agree with this. Is there anything that you would have added to this whole process that makes the whole thing a bit stronger. Please let me know in the comments below. And if you haven’t done so yet hit the subscribe button. It doesn’t cost you anything and it really helps our channel a lot. If you subscribe and come back and watch future videos. So thank you for stick with me all the way to the end of the video. I’ll see in the next video I hope you enjoyed this. Thanks.

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