Mark Draper (GEM Capital) writes a monthly column for the Australian Financial Review. In his January 2019 article he outlines some of the triggers investors should look for that provide clues for when to sell.
7 flags to tell you ‘it’s time to sell’
The days of the ‘buy and hold’ strategy has long been a ‘dinosaur’ and probably always was. Regular changes to technology, regulation, consumer tastes not to mention competitors can turn today’s hero investments into tomorrows dogs.
Successful investing involves not only buying assets for a reasonable price, but also knowing when to sell.
The term ‘red flag’ is referred to by professional investors as events that take place that act as an early warning signal to sell.
Here are 7 red flags to help investors sell before ‘it hits the fan’:
- When directors sell shares in their own company, particularly when more than one director sells in a short period of time, investors should be nervous. History is littered with examples of director selling followed by dramatic falls in share prices. In August 2016 the CEO and Chairman of Bellamys both sold a combined total of 365,000 shares at around $14.50 per share. In June 2018 two directors of Kogan sold 6,000,000 shares at $7 per share. The share price charts below tell the rest of the story. INSERT Bellamy’s and Kogan charts (attached PDF’s)
- Crowded trades takes place when consensus opinion on an investment is universally positive which usually coincides with excessive valuation. The ‘investment that can not lose’, verbalised by cab drivers and instant experts at barbecues is usually a place to avoid. Crowded trades could also be referred to as fads.
Who can forget the mantra in 2007/2008 about peak oil theory, when the oil price was around $150 per barrel. Investing in energy was a one way bet according to common beliefs of the day, providing an excellent example of the crowded trade. Oil today of course trades today at around $60 per barrel.
- Poor behaviour from management which include directors/management using company assets for private use, related party transactions such as the company renting premises from directors and excessive management remuneration.
- A google search of Nepotism reveals “the practice among those with power or influence of favouring relatives or friends, especially by giving them jobs”. Whether employing a relative or friend of management, or the company expanding into an unrelated business, so that a relative can run it, rarely results in getting the best person for the job.
- Most investors appreciate that a company’s share price follows the earnings. Earnings should follow cash flow, so when earnings rise without a corresponding rise in cash flow, investors should beware.
- My father always said to me ‘everything comes from the top’, and how true this is with respect to investing. Changes to management can play a big role in share holder returns. A Financial Services executive employed to run a healthcare company? A Milkman running a Childcare company? True situations that didn’t end well for shareholders. Investors should consider the background and experience of new management that is appointed to satisfy themselves that they are fit for the role.
- Valuation is the ultimate red flag. Buy low and sell high sounds simple but the only way an investor can do this is to first hold a view of what an asset is worth. While this seems elementary, I continue to be surprised by investor behaviour which clearly demonstrates no regard for valuation.
Let us pay tribute to the poor souls who invested in Cisco Systems at the height of the dot.com bubble paying well in excess of 100 times earnings. Almost 20 years later, the share price is still not back to its level at the peak of the dot.com boom.
And there were many examples of this behaviour in Australian technology stocks in the dot.com boom that didn’t even have a price earnings ratio due to the fact that the company’s didn’t have any earnings to show. Crypto currency is possibly the most recent example of investors chasing returns from an asset without regard for intrinsic value.
7 flags to help investors keep from trouble. As the great Kenny Rogers song said, “you gotta know when to hold ‘em, know when to fold em’, know when to walk away and know when to run. Happy investing!