Seeking out and buying bargain-priced stocks is the cornerstone of any successful investing approach. But investors all too often get overly focused on the purchase side of the equation, when it is selling a stock for more than the purchase price that brings rewards.
One must know how to identify -- or value -- a bargain stock in order to know when to sell it for a profit. Serious investors devote a great deal of time to hunting and analyzing the field for bargain stocks.
The goal of all investors is to buy low and sell high. However, investors should heed one certain fact. I have routinely said that rarely will any investor buy a stock at the absolute bottom -- if you do, consider it more an element of luck than skill. Just the same, most investors will never, ever sell at the top, and if you do, again consider yourself lucky. Fortunately, investors are not rewarded in the long term for being great market timers. One approach for a successful value investor is to do only two things over and over:
- Only buy securities that are selling at a discount to intrinsic value.
- Sell securities when they have reached fair value.
Notice how we are not concerned with selling overvalued stocks, only fairly valued ones. One need only focus on buying underpriced stocks, selling the fairly priced stocks, and avoiding the overpriced stocks.
A recent example from the master
A short while ago, master investor Warren Buffett was selling off Berkshire Hathaway's (NYSE: BRK-A ) (NYSE: BRK-B ) stake in Chinese oil giant PetroChina (NYSE: PTR ) . When Buffett decided to purchase PetroChina, he did not know how much the company's shares were trading for. (Buffett has stated that he avoids looking at a company's stock price until he has valued the business himself.)
After reading the annual report, Buffett concluded that PetroChina was significantly undervalued, and he put some $500 million to work. At the time, Buffett's investment was for about 1.3% of the overall shares, so PetroChina's market cap (based on the Hong Kong & New York American depositary share prices) was around $39 billion. While companies like ExxonMobil (NYSE: XOM ) were valued at several times PetroChina's market cap, Buffett liked the price he was paying.
Recently, Buffett sold off his 1.3% stake for some $3.5 billion, suggesting an overall market cap of approximately $270 billion. But very shortly after Buffett's sale, PetroChina had a market cap exceeding $400 billion (ADR price), making it the second-most valuable company in the world: after Exxon and ahead of General Electric (NYSE: GE ) .
Always witty, Buffett quipped that he sold too early. Yet Buffett was very comfortable selling when he did. At roughly $270 billion, Buffett felt that PetroChina was fairly valued. Does this mean that the company is overvalued at more than $270 billion? Not necessarily. It made no difference that Buffett did not buy at the bottom and did not sell at the top. What made a difference was buying an undervalued business and selling a fairly valued one.
Sure, it doesn't hurt that Buffett made a ton of money, but then again that's the reward one gets when investing big in a bargain stock.
Sure, you can get lucky
The important aspect of selling stocks is the process involved and not the end result. Of course, at the end of the day, you want to have a realized capital gain. But buying an excellent business like Chipotle (NYSE: CMG ) at the not-so-excellent price of 70 times earnings and selling at 80 times earnings is not buying low and selling high. It's buying high and getting lucky enough to sell higher. In the long run, that type of approach will decimate investor returns. Ultimately, the art of selling high becomes much easier when bargain securities are purchased.
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