This article is authored by MOI Global instructor Gary Mishuris, Chief Investment Officer of Silver Ring Value Partners, based in Boston.
I have spent some time thinking about my process for exiting an investment. This reflection has led me to conclude that I can improve my process, both by selling sooner and by holding on to investments longer. In each case some of my prior decisions were influenced by anchoring on the initial value range and not being sufficiently responsive to new evidence.
When I look back on when my selling decisions had turned out to be correct, it was frequently for the same reason: fundamentals had structurally deteriorated, I had reduced my value range and exited the investment. I have a number of examples in mind, most recently my decision to sell Hill International (HIL) which, shortly after I sold it following meaningfully restated financial statements, got cut in half. It wasn’t easy to drastically reduce my value range as my mind was resisting admitting a mistake, but the fact that I did so in time saved us several percent of our capital.
Conversely, when I look at when I had sold too early, it was invariably in situations where the fundamentals remained strong but valuation had gotten high, closing the gap to my base case value. In many cases, with the benefit of hindsight I came to realize that the value of the business was much higher than I thought at the time that I was selling. In a number of cases I believe that was knowable at the time based on the information available, but that anchoring caused me to be too slow to update my value range based on the evidence. Value investors are taught to be disciplined on valuation and, for many of us, raising our estimate of value as the stock price goes up just feels wrong.
Investing is difficult in part because it is both an art and a science. How much information do we need before we should meaningfully change our value range? Are there situations when a seemingly small piece of evidence should lead us to meaningfully change our value estimate? As a result of my reflection I plan to be more responsive to evidence in either direction that suggests that my base case value should be meaningfully different than my current estimate in the following ways:
If the new negative information is more likely to be structural than temporary or cyclical, then it is important to drastically re-underwrite the investment and question all prior assumptions. It is rare for structural deterioration to be isolated to a quarter or two – more likely it is a harbinger of additional bad news down the road.
As a value investor I have a tendency to be conservative in my initial assumptions. When I make an initial investment I do not want to do so based on a value estimate that is stretched to the limits of what is possibly justifiable by the facts. While I try to be as accurate as possible and this is not an intentional low-balling of my base case value estimate, not stretching assumptions provides an extra margin of safety when deciding whether the security is sufficiently undervalued for purchase. When subsequent positive developments occur, I have sometimes been too slow to make large changes to my value estimate, anchoring on my initial conclusion.
Going forward, what I plan to do differently is:
1. Treat negative structural news as an immediate red flag, leading to re-underwriting the investment rather than waiting for multiple quarters of such news before doing so.
2. Use the Thesis Tracker more frequently to force myself to update the value estimates following better than expected business developments. I plan to re-evaluate my value any time two quarters of better than expected results occur or following any quarter where I learn unexpected structural good news.
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