I’ve been a fund manager for decades – here’s when to cut your losses and run
It happens rarely, but any stock picker lives in fear of backing the wrong company. Without a crystal ball, it’s hard to judge when to stick by a holding and when to call it a day.
I recently listened to an address by one of the UK’s leading technology entrepreneurs who said experience counts for nothing – what matters is what you decide today.
I have a lot of time for this mantra, but when investing in UK smaller companies as I do, there are nonetheless a number of principles I’ve found that act as a useful guide.
Give it six months, then cut your losses if necessary
When we invest, we give each company a score between one and five on how bullish we are for the short term. We also write down the briefest of rationales for investing. After the first six months, if your original score or rationale no longer applies, it’s time to change tack.
Imagine the post-Christmas period in January and the waistband is bulging. You sign up with a personal trainer in the hope that the six-packs consumed in December morph into their voguish muscular cousins.
But it turns out that these toned, hyper-positive fitness fanatics are actually quite annoying, and their programme of push-ups and planks aren’t working as well as you hoped. Instead, you discover that cycling is the thing for you. The best thing to do is ditch the personal trainer and buy some proper wheels instead.
If a stock’s not performing as you expected, so too is it advisable to exit a failed investment swiftly at limited cost and move on to simpler ways to hit your fitness, or financial, goals.
Recognise when the ship is sinking
While larger companies can generally shake off a bad quarter, if their smaller brethren miss profit targets, market credibility is easily lost.
Smaller companies often need to sail back to port for a refit after suffering a blow beneath the waterline. That usually involves a new crew (management team) and some expensive repairs, which shareholders will have to fund.
There are of course exceptions, but companies which demand increased care and attention can be disruptive. All of this points to being disciplined about moving on when we suspect a corporate refresh won’t pan out.
Don’t ignore the share price
It is very easy to fall in love with a company and ignore its valuation. The management team is engaging, the product is exciting and the factory tour has you mesmerised.
Then, low and behold, you find out the executive bonus is large and about to be paid, the product is faulty and the last run you saw being manufactured is now stuck in the distributor’s warehouse.
If a holding underperforms and drops below 1pc of our portfolio, it’s automatically for sale.
Spend the time on the holdings which matter most
Think of your portfolio as a rugby squad. Start with your first XV, your best-performing players, some of whom may be nearing retirement and coming to the end of their roles in the team.
Then you have the second XV, after which comes your academy team, some of whom will make it into the big leagues while others will jog off into obscurity. If the squad is working well, you should be able to take profits from the top of the portfolio and deploy them to the bottom.
In investments, there is no television match official who can rewind the game to get the right result. It is much more productive and profitable to spend the most time on your best performing players. If a company can’t cope in the scrum, it’s time to head to the bench.
Of course, there are no hard and fast rules investors can follow to make it more likely you back a winning stock. Any number of factors can unexpectedly turn the tide on a company’s prospects.
But understanding when to sell can be just as critical as knowing what to buy.