Tuesday, 3 April 2018

How Warren determines it is time to sell


In Warren's world you would never sell one of these wonderful businesses as long as it maintained its durable competitive advantage. The simple reason is that the longer you hold on to them, the better you do. Also, if at any time you sold one these great investments, you would be inviting the taxman to the party. Inviting the taxman to your party too many times makes it very hard to get superrich. Consider this: Warren's company has about $36 billion in capital gains from his investments in companies that have durable competitive advantages. This is wealth he hasn't yet paid a dime of tax on, and if he has it his way, he never will.

Still, there are times that it is advantageous to sell one of these wonderful businesses. The first is when you need money to make an investment in an even better company at a better price, which occasionally happens.

The second is when the company looks like it is going to lose its durable competitive advantage. This happens periodically, as with newspapers and television stations. Both of them used to be fantastic businesses. But the Internet came along and suddenly the durability of their competitive advantage was called into question. A questionable competitive advantage is not where you want to keep your money long-term.

The third is during bull markets when the stock market, in an insane buying frenzy, sends the prices on these fantastic businesses through the ceiling. In these cases, the current selling price of the company's stock far exceeds the long-term economic realities of the business. And the long-term economic realities of a business are like gravity when stock prices climb up into the outer limits. Eventually they will pull the stock price back down to earth. If they climb too high, the economics of selling and putting the proceeds into another investment may outweigh the benefits afforded by continued ownership of the business. Think of it this way: If we can project that the business we own will earn $10 million over the next twenty years, and someone today offer us $5 million for the entire company, do we take it? If we can only invest the $5 million at a 2% annual compounding rate of return, probably not, since the $5 million invested today at a 2% compounding annual rate of return would he worth only $7.4 million by year twenty. Not a great deal for us. But if we could get an annual compounding rate of return of 8%, our $5 million would have grown to $23 million by year twenty. Suddenly, selling out looks like a real sweet deal.

A simple rule is that when we see P/E ratios of 40 or more on these super companies, and it does occasionally happen, it just might be time to sell. But if we do sell into a raging bull market, then we shouldn't go out and buy something else trading at 40 times earnings. Instead, we should take a break, put our money into U.S. Treasuries and wait for the next bear market. Because there is always another bear market right around the corner, just waiting to give us the golden opportunity to buy into one or more of these amazing durable competitive advantage businesses that will, over the long-term, make us super superrich.

Just like Warren Buffett.

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