Thomas E. Finser
The Buy Discipline
Paralysis by analysis is a common pitfall in bottom-up strategies. There is always something else to learn about a company. Therefore, it is highly important to recognize that only so much writing, reading, interviewing, and high-level thinking can be done. The key is to know when an accumulated body of knowledge is sufficient, a determination that is more art than science. To this end, I use the Peter Drucker rule: The decision jumps out once the facts are clear.
Before a purchase, the investment plan is mapped out on paper, outlining all expectations, risks, and contingencies. A brief checklist documents the major assumptions, projected outcomes, deadlines, and timelines. The analysts or portfolio managers (PM) involved briefly describe their current personal situation, state of health, and other life events. An analyst might unwittingly become entangled in an investment idea because of personal reasons that should be identified before any capital commitment.
Although an investment overview may be published in public forums such as Seeking Alpha, the one- to two-page, internal buy thesis remains private. Memories and affirmative statements change with the wind. Once the buy thesis is in writing, we still might reconsider our judgment as unforeseen events unfold. Public statements and proclamations, on the other hand, are prone to calcified thinking and confirmation bias, causing analysts to dig in and fight for their pet investment thesis. Thus, by putting the buy thesis in writing but keeping it private, we temper flexible memory in which facts change with a concrete, immutable, historical reference point. We can back down from an incorrect thesis without indulging in excusing ourselves.
The Sell Discipline
Selling is the hardest part. Once a stock has earned a place in a portfolio, the process is only half complete. Exiting the position is the second half and requires more discipline and nearly the same analytical workload as the initial buy decision. After all, since capital gains are recycled into new ideas, equally rigorous analysis must test new ideas against the old in order to swap out for higher internal rate of return (IRR) opportunities. Proactively pruning the old to make room for the new thus necessitates double due diligence.
Maintaining a sell discipline alleviates these challenges. The buy thesis outlines the foundational assumptions, objectives, valuations, and price-to-value targets. Because most portfolio holdings are idiosyncratic and have multiple inflection-point catalysts, no fixed price targets are set. Instead, I use margin-of-safety targets, a threshold lower than fair value which, if crossed, leads to a stock sale. Shareholder NAV, however, can and should grow over time. I might keep a rapidly appreciating stock that continues to sell below fair value for many years.
Avoiding landmines is the most important aspect of the sell discipline. Once again, the buy thesis checklist provides accountability. We constantly ask whether, at today’s price and with the knowledge that we have today, we would repurchase the stock. Prompting this question is another advantage of a concentrated portfolio: It leaves little room for dead wood and lurking low-conviction stocks.
The most common reasons for selling include
In most cases, stock is sold because a combination of factors reduces the margin of safety, and a more favorable risk-reward opportunity arises. However, my preferred exit is self-liquidation through capital distributions, special dividends, and buyouts.
Paralysis by analysis is a common pitfall in bottom-up strategies. There is always something else to learn about a company. Therefore, it is highly important to recognize that only so much writing, reading, interviewing, and high-level thinking can be done. The key is to know when an accumulated body of knowledge is sufficient, a determination that is more art than science. To this end, I use the Peter Drucker rule: The decision jumps out once the facts are clear.
Before a purchase, the investment plan is mapped out on paper, outlining all expectations, risks, and contingencies. A brief checklist documents the major assumptions, projected outcomes, deadlines, and timelines. The analysts or portfolio managers (PM) involved briefly describe their current personal situation, state of health, and other life events. An analyst might unwittingly become entangled in an investment idea because of personal reasons that should be identified before any capital commitment.
Although an investment overview may be published in public forums such as Seeking Alpha, the one- to two-page, internal buy thesis remains private. Memories and affirmative statements change with the wind. Once the buy thesis is in writing, we still might reconsider our judgment as unforeseen events unfold. Public statements and proclamations, on the other hand, are prone to calcified thinking and confirmation bias, causing analysts to dig in and fight for their pet investment thesis. Thus, by putting the buy thesis in writing but keeping it private, we temper flexible memory in which facts change with a concrete, immutable, historical reference point. We can back down from an incorrect thesis without indulging in excusing ourselves.
The Sell Discipline
Selling is the hardest part. Once a stock has earned a place in a portfolio, the process is only half complete. Exiting the position is the second half and requires more discipline and nearly the same analytical workload as the initial buy decision. After all, since capital gains are recycled into new ideas, equally rigorous analysis must test new ideas against the old in order to swap out for higher internal rate of return (IRR) opportunities. Proactively pruning the old to make room for the new thus necessitates double due diligence.
Maintaining a sell discipline alleviates these challenges. The buy thesis outlines the foundational assumptions, objectives, valuations, and price-to-value targets. Because most portfolio holdings are idiosyncratic and have multiple inflection-point catalysts, no fixed price targets are set. Instead, I use margin-of-safety targets, a threshold lower than fair value which, if crossed, leads to a stock sale. Shareholder NAV, however, can and should grow over time. I might keep a rapidly appreciating stock that continues to sell below fair value for many years.
Avoiding landmines is the most important aspect of the sell discipline. Once again, the buy thesis checklist provides accountability. We constantly ask whether, at today’s price and with the knowledge that we have today, we would repurchase the stock. Prompting this question is another advantage of a concentrated portfolio: It leaves little room for dead wood and lurking low-conviction stocks.
The most common reasons for selling include
- Price has reached fair value, and the margin of safety is no longer present.
- Unexpected impairment results from a deterioration of business fundamentals.
- Better investment opportunities with more favorable risk-reward profiles emerge.
- Self-liquidation occurs through capital distributions.
In most cases, stock is sold because a combination of factors reduces the margin of safety, and a more favorable risk-reward opportunity arises. However, my preferred exit is self-liquidation through capital distributions, special dividends, and buyouts.