Motley Fool Hidden Gems Investing - The Pitfalls of Selling Stocks (and How to Avoid Them)

Starting point is 00:00:00 Emily Flippen Some of the biggest mistakes investors make aren't the stocks they buy, they're the ones they sell. We're reflecting on past selling missteps today on Motley Fool Money. It's Tuesday, November 25th. Welcome to Motley Fool Money. I'm your host, Emily Flippen, and today I'm joined by Fool analysts Jason Hall and Jess Santoro to discuss one of the most dangerous things investors can do, selling good companies too soon. Today, we're going to be looking back at some of the Rule Breaker and Stock Advisor recommendations that we sold that went on to become 5, 10, and even 100 baggers to hopefully help you, our listeners, build a healthier mindset around when to sell,

Starting point is 00:00:44 when not to, and why buy and hold investing still usually wins out. Jason, I want to start big picture here. If you look back at many of our full scorecards, we've had some amazing winners, And, of course, some absolutely brutal mistakes. And many of these mistakes, in my opinion, the worst ones are the ones that we sell, right? What is it about selling that is so emotionally tempting to investors, even those like us that claim to be very long-term? So, as investors, we try to be high-minded. We have these financial goals, long-term and short-term, that we're trying to reach. But we're also humans, and humans are messy.

Starting point is 00:01:17 We're just not wired to really be good at investing. Fear and greed are exceptionally strong emotions. we search for confirmation bias, and there's always a data point that feeds what you want to believe to be true, whether it's actually the right thing to act on or not. If we own a great stock or maybe we just get lucky and we buy a stock and it doubles, those old tropes start to sound smart. It's house money. I'm going to lock in my profits. Now, if we own a stock that falls in value. Again, this is like that meat sack part of us in our brain that we don't really always understand that we have to fight against. The value of a stock going down hurts more than

Starting point is 00:02:02 a stock going up feels good. They've done studies and looked at our brains and our pain centers actually fire when we've perceived that we've lost money. So often we sell in both cases. In the case of a stock that's falling, we sell to make the pain stop. And then the stock that's gone up in value, we sell to avoid the imagined future pain when the stock is inevitably going to fall in value again. Yeah. In my experience, investors always have this process and usually determine that their risk tolerance is higher than what it actually is. And it's not until you're sitting on a lot of unexpected losses that investors realize, oh no, maybe I wasn't as risk-tolerant, or I am more risk-averse than I'm giving myself credit for.

Starting point is 00:02:46 And this is true for all of us. When you look at the emotional decisions that an investor makes, we're pretty good about focusing on the long-term here at The Fool. We talk about it a lot, but we're still not perfect. And one of the classic examples that comes to mind for me is David Gardner, who sold Netflix and Stock Advisor back in 2003 for valuation reasons. And at the time, to your point, Jason, that was locking in some really, really nice gains. And it looked like a smart move in the short term because Netflix did go on to fall nearly 60% over the course of the following year. And of course, David eventually corrected this mistake and ended up re-recommending Netflix many times after that. But if he had just held on, that

Starting point is 00:03:22 initial sale would have resulted in 26,000% gains, which is obviously making up for any amounts of those near-term losses. So Jeff, I mean, that's how it stands out to me. When you look at the sell history here at The Fool, Netflix aside. I mean, what stands out to you? So one stock that stands out to me is C Limited, ticker symbol SE, because I share the same regret that some of the analysts might have with this one. So Rule Breaker sold this stock in November of 2023 after putting it in the penalty box, which is where we stick stocks when we're not sure what to do and we're just holding onto them to see how things go. That sale missed out on 223% gains, and that's compared to 44% gains for the S&P 500. So we sold out of a stock that was going

Starting point is 00:04:04 to beat the market. Now, at the time, the reasons for selling were logical. Competition was hurting margins. And after flirting with profitability for the last few quarters, C suddenly posted quarterly net loss. So the future looking a little more murky than perhaps we thought. Hindsight's 20-20. C Limited's net income was about to march up and to the right for the next several quarters. And in the most recently reported quarter, net income hit $375 million, which was a 145% increase over the previous year. So the lesson here, I think, is that sometimes patience pays off. The strong top line growth in the e-commerce and fintech sectors could have been enough reason to hold on until the bottom line turned things around. And sometimes we need to

Starting point is 00:04:47 have the conviction to look at the whole business and not just the struggling metrics. And I was guilty of the same impatience. I sold my shares just a few weeks before the Motley Fool analyst decided to do the same thing. But as you mentioned with Netflix, selling too soon doesn't mean you are locked out forever. These massive winners often offer many opportunities to get back in. I love that. It's never too late. Sometimes people think that I've made a mistake and you had the sunk cost fallacy behind it all. And the reality is that there's no mistake that's too late to correct. And I know we've already hit on a couple of big themes here, right? our emotions. I hate the volatility and the math of big winners typically is way more powerful than

Starting point is 00:05:22 our brains clearly want to admit. But up next, we're going to be walking through a few more of those, like we sold this and then watched it soar stories, and then pull out some of the patterns that we think investors should be looking out for. So stick with us. Welcome back to Motley Fool Money. We're talking about the pitfalls of selling stocks. And as such, I think it's time that we need to say, roast ourselves a little bit by looking at some specific cells that aged rather poorly. Prior to today's show, I pulled together a list of some of the best performing sales from Stock Advisor and Rule Breakers. And it's important to note that these are, of course, cherry picked. There's plenty of stock recommendations that were, at least so far,

Starting point is 00:05:59 the right choice. But hopefully when we look at these, we can see some common denominators about what made these the wrong choice. This list included companies like you mentioned, Jeff, Sea Limited, but also companies like First Solar, Chipotle, Garmin, Royal Caribbean, all of which are up hundreds, if not thousands, of percentage points since being sold. Jeff, I want to start with you. When you first looked at that list that I sent around, what jumped out? Were there common reasons that we gave for selling that, in hindsight, just weren't as strong as they felt in the moment? So, it's easy to look back at this list and simply blame a lack of patience. I mean,

Starting point is 00:06:31 you could make that argument for any stock that you sell that eventually goes up. I think that's unfair to us as investors because it assumes that we could see the future. So, with Sea Limited, as I mentioned, the fundamentals like the lack of profitability and intense competition were actually reasonable grounds to sell at the time. We just didn't know what the future was going to hold. I looked through that list. First, solar to me is a different story. So that was sold in 2012. And I think it's important to remember that the environment back then for the solar industry and 2012 solar accounted for less than 1% of total energy production in the United States. So I think we can cut ourselves some slack with that one.

Starting point is 00:07:05 The missing piece there wasn't patience. I think it was imagination. I don't know that we were able to understand how drastically the costs of production would plummet, how legislation would eventually help and fuel the industry. And another one that jumped out to me is Chipotle. So the 2020-12 sell of that stock was actually not a full sell, but a trim. And I think there's a great lesson here. Sometimes trimming a stock rather than selling the whole position can let you act on a valuation

Starting point is 00:07:31 concern without selling completely out and then missing the rest of the ride. So that nuance, I think, actually paid off. And Rule Breakers actually added back to the position in 2016, and those shares are up 275% since that buy, and that's beating the market by 70 points. Even still, with the massive pullback in Chipotle, that's comparatively impressive. I mean, I'm sure a lot of those sales probably felt rational at the time. And I always think to myself before I try to make these decisions, what key components am I missing?

Starting point is 00:07:59 What change or sentiment can drive that growth that I really didn't fully appreciate at the time, right? it's important to reflect and recognize where I went wrong. But Jason, I'm hoping you can talk to me a little bit about the quantitative angle of selling. In particular, why it can be so bad for a portfolio to sell a stock that ends up being 100 plus bagger, rather than just holding on to a bunch of stocks that do ultimately go to zero. How does the math work there? Yeah. We don't even need to use 100 bagger. They're extremely rare. We can use just your old run of the mill 15 bagger. That's not run of the mill. But what I'm saying is it's really,

Starting point is 00:08:33 really impressive what happens with these stocks that go on to be big winners. But I want to start, Warren Buffett is famous for his quote, first and second rules of investing, don't lose money and see rule number one. But if we take this on a single stock level, it's just myopic and ridiculously impossible. Warren Buffett probably wrote more words about his investing mistakes than he did his successes. And if the greatest of our time has failures, that means it's okay. So it's less about batting average and more about slugging percentage, to throw a sports metaphor in here. But the process, when we think about it, more holistic, I think that really helps us as investors. And it's been said a million times, the most you can lose on a single stock you bought is 100% while the upside is theoretically unlimited.

Starting point is 00:09:22 Realistically, upside is definitely limited for most businesses. But the kernel there is asymmetric returns, meaning that the upside is far greater than the downside. That's a feature of investing stocks. When you start making that part of your mindset and the way you think about stocks, it really helps. Now, let's use MercadoLibre and Intuitive Surgical just as a couple of rule-breaker examples.

Starting point is 00:09:46 These have been in the rule-breaker service for a very long time. They're big winners. We can go back to the beginning of 2010 for both, just as an example. I think the market is up around 700% in total returns since that period. That's an incredible run for the stock market. But Intuitive Surgical is up 1,570%. MercadoLibre is a 39-bagger. So we've gotten 16 times and 39 times that initial investment in total returns on those two stocks.

Starting point is 00:10:15 Now, to put it another way, Emily, and this is where it gets really powerful. let's say you bought intuitive surgical back in 2010 and you also bought 10 other stocks at the same time invested the same money in those other 10 stocks and all 10 of them went bankrupt you still would have earned 570 percent in gains because intuitive surgical did well now if it was mercado libre you could have bought mercado libre and 37 other stocks that went to zero and you still would have made money. The point is, if you sold out of either of those companies along the way because of competition concerns, valuation concerns, macro concerns, and there were plenty of opportunities along the way to do it, you would have missed out on their strong

Starting point is 00:11:00 growth, which by the way, Jeff, you mentioned this before, it's not over for either of these companies. I love the way you say that, Jason. And that's the way the market works too. It's easy for people to forget that when you buy an index fund, that the majority of companies underperform their own index. It's those handful of companies that go on to produce massive returns that results in virtually all of the gains of the stock market. I'm looking at my personal portfolio. I pulled it up while you were talking, Jason, on Fidelity. And I'm outperforming the market by about 1% this year. But if you actually look at some of my individual companies, I see a lot of red, a lot of stocks that I have lost 96, 95, 73, 78%. I'm just reading off the numbers

Starting point is 00:11:42 in front of my screen here, but the ones that have done well have more than made up for it. After the break, we're going to be flipping in the script and talking about when selling actually does make sense and how to build a framework that can help us stay invested as winners. Stick with us. Welcome back to Motley Fool Money. To round out the show, I want to make sure that we don't leave people with the idea that the only foolish move is to hold everything forever, no matter what. So let's talk about some good reasons to sell and how long-term investors can create maybe like a framework that keeps them from churning, but still leaves room to course correct their portfolio when needed. Jason, if you had to lay out a short checklist

Starting point is 00:12:16 for like, this is when it's reasonable to consider selling for an average investor, what would be on it for yourself? Emily, I want to start by saying, I love that you use the word framework there. I described earlier how our human nature sets us up to fail as investors. And a good framework beats rules all day. Rules are stupid things like selling half of a stock that doubles and thinking of things as house money. A framework helps us build a process that would assist us in making better decisions. More importantly, it makes us harder to take actions that are not in our own best interest. So my checklist for selling includes a few things. The first, if I'm selling because I've reached a financial milestone and it's time

Starting point is 00:12:53 for me to sell stock. Maybe I need to shift some of that stock wealth I've accumulated to bonds or to cash because I'm closing in on a financial goal. Maybe I'm in retirement or it's part of my income strategy. Number one, that's great. Guess what? You're selling because you've reached financial goals. That's optimal. Now, if it's not for one of those reasons, you have to start asking myself some questions. And I start with asking, am I selling for business reasons, macro reasons or valuation reasons if the business is no longer meeting my thesis expectations what has changed what's changed in the business and then i start asking myself well has that changed because of the business for competition or a macro reason right if a

Starting point is 00:13:33 business is going through a tough time and in the cycle macro things often i force myself to really reevaluate my thought process because history tells us the worst time to selling a struggling stock is when macro or cycle factors are causing it to struggle, you're probably selling the bottom. If it's valuation, I force myself to evaluate the business from a longer-term perspective because using valuation for a very mature company like a Walmart or a Target is very different than a growth-oriented one like the Rule Breakers that we've talked about, particularly for investors with very long time horizons.

Starting point is 00:14:09 My biggest sell mistakes were for valuation on businesses that can easily grow their revenues by 5 or 10x their current levels over the next 10 or 20 years. It's almost always best to hold on in those cases if the business is historically done pretty well. Valuation might make sense if it's a mature company that doesn't have those kind of growth things. Now, I do two more things too, Emily. I asked myself this question, if the stock doubles in five years or it goes up 5X over

Starting point is 00:14:42 the next decade, will I regret selling it? And then I forced myself to wait two market days once I've made a decision before acting on that sell decision, cooling off period and regret minimization. Those two things go a long way towards avoiding making those selling mistakes. I like that. And you know what? I didn't consciously use the word framework instead of rules, but now I'm going to be consciously using the word framework instead of rules moving forward. I think when I think about

Starting point is 00:15:08 the mistakes, I see investors always telling me the share price performance is representative of the company performance, right? Just because the share price for a company has changed doesn't mean that the business fundamentals have changed. And I think it's important to draw that distinction because selling or buying just because the share price has changed or fallen isn't the same thing as reflecting on business performance or your thesis, right? And a lot of times our timeline is much longer than the people who are driving those ins and outs of the daily markets. Jeff, last question here. On a practical level, is there anything that you do that helps keep yourself from over-trading or selling too soon? I hesitate now to use the word rules after Jason applauded

Starting point is 00:15:44 framework, but do you have rules or a framework for yourself? I am a big fan of frameworks. I have to give Jason credit. He summarized a lot of what I was going to say in his last answer, but here's a couple more things that I do. I try to build some friction into my selling process. So once I start to have any thoughts about wanting to sell a stock in my portfolio, I force myself to go back and reread the most recent earnings report, the transcript, the press release. I force myself to get back into the numbers, because as much as we all do this for a living and think about this all the time, I find myself getting caught up in the news of the

Starting point is 00:16:18 financial media and what the stock price is doing. And I find that going back and actually looking at hard data, I will often see things I forgot. Oh, I forgot that this thing was heading in the right direction, or I didn't remember that management said this on the earnings call. And a lot of times that gives me clarity and makes me feel less of the impulse to sell. And look, nobody's perfect. Sometimes holding on is a mistake. Sometimes the stock does not recover.

Starting point is 00:16:42 I just like to be extra cautious on a sell for all the reasons we talked about today. I feel the same way, Jeff. And I appreciate both your perspective and Jason's perspective for ourselves here. As we head into the Thanksgiving week here in the United States, it's always nice to have a little slice of humble pie with our turkey. And I certainly feel like after reflecting on some of these sales and mistakes that I know I have contributed to in my role on a stock advisor as an analyst, it's good to reflect and take some of these lessons. I hope our listeners are able to take these lessons and use them for their own

Starting point is 00:17:11 portfolios as well. Jeff, Jason, thank you both so much again for joining. Happy Thanksgiving, Emily. Happy Thanksgiving. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows the Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. For Jason Hall, Jeff Santoro,

Starting point is 00:17:39 and the entire Motley Fool Money team, I'm Emily Flippen. We'll see you tomorrow.

Motley Fool Hidden Gems Investing - The Pitfalls of Selling Stocks (and How to Avoid Them)

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