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I’ve met with and researched hundreds of fund managers over my career. One theme that has been consistent across nearly all of my research is this: the hardest investment decision to make is knowing when to sell.
As soon as a security is purchased, the buyer loses the power to avoid a decision. It becomes necessary for him to decide whether to hold or sell. As an inexorable consequence, the percentage of correct conclusions must be lowered. Therefore, intelligent investors expect to make a great many more errors in closing transactions than in opening them.
An investor looking to buy can afford to be choosy. They can pass on potential investments until they find a suitable opportunity. Warren Buffett famously refers to this as waiting for the “fat pitch”. On the other hand, an investor can’t pass when it comes to an investment that they hold. Instead, they make a decision not to sell every day that they continue to hold a stock.
I’m facing a tough hold or sell decision at the moment. Back in November, I valued Blackmores (BKL) at $35.70 a share and the stock was trading around $33.00 per share (see my post here and my valuation here).
BKL has experienced a significant turnaround in operating margins – up from around 11% to 17% (most recent quarter). Revenues have grown at a very impressive rate of 28% over the last 9 months. Most of the improvement has taken place in the Australian business which accounts for roughly 70% of Blackmore’s revenues.
The company’s stock now trades on an all-time high of over $78.00.
Last week, I decided to re-value BKL. You can find a copy of my latest valuation here.
My valuation is $57.48, which is based on the following assumptions:
- Sales growth of 15% for the next 5 years, fading to around 3% 10 years from now.
- Long-term EBIT margin of 13%.
- A rate of capital investment as a percentage of sales that is higher than BKL’s historical re-investment rate.
These assumptions are reasonably conservative and they result in an intrinsic value that is approximately 30% lower than the current market value. Should I hold or should I sell?
Reasons to sell include:
- Intrinsic valuation.
- Relative valuation – BKL trades on a trailing 12-month P/E ratio of 40.30x and a P/B ratio of 11.10x.
Reasons to hold include:
- The stock looks cheap IF (a big if) current revenue growth and margins are sustainable.
- Profitability. BKL has a strong brand which allows it to charge premium prices. Consequently, return on invested capital (ROIC) is both high and relatively sustainable.
- Consistent long-term sales growth. The average over the last 10 years is 11.55% per annum.
- Momentum – investors are now starting to pay attention to BKL again after having avoided the stock in 2012-2013.
The table below shows how my intrinsic valuation varies as revenue growth and EBIT margin assumptions change. Values in yellow represent combinations that indicate BKL is approximately fairly valued (i.e. intrinsic value is close to current market value), values in red indicate that the stock is expensive, while values in green indicate that the stock is cheap.
I’ve recently started making more disciplined use of this sort of analysis, ensuring that I consider a wide range of outcomes rather than a single forecast. The reason for this is my unpleasant experience with another stock – Metcash (MTS). You can find a copy of my MTS valuation here.
The mistake that I made with MTS was to assume that EBIT margins would revert back to long-term average levels. I didn’t spend much time a) considering what would happen if they deteriorated further and b) what might cause that to happen. The result was that I am now the proud owner of a “deferred tax asset” (a euphemism for a loss of around 30%).
Fund manager and author Ken Fisher writes that investors should welcome mistakes as opportunities to learn. he suggests that, rather than try to avoid mistakes, we “accumulate regrets”.
So with this in mind, I think of my loss on MTS as an investment in making sure that I always check my margin assumptions before investing! I will never forget to try to identify the factors that may cause my assumptions to change or be incorrect. An I will be sure to thoroughly investigate the impact of a range of assumptions on my valuation estimates.
I’m leaning towards holding onto BKL for now. The main reason is price momentum. Experience has shown that prices can continue to run up (or down) for longer than my investment research may suggest.
Every investor has heard the old adages:
- Buy low, sell high.
- Cut your losers and let your winners run.
I followed the first adage when I originally bought BKL back in 2013 when I thought it was cheap and now I’m trying to apply the second proverb. Its hard to do, especially following a very large and very rapid increase in price. Loeb explains why:
Another reason why selling at the right time is more difficult than buying is that the development of a frame of mind in which only real bargains are sought carries with it a tendency to lose confidence too early. Periods of overvaluation and public over-confidence are, naturally enough, likely to follow periods of depression, and often do. Likewise, very good general business conditions will normally succeed very bad conditions. in such active periods, stocks will sell at the most optimistic expectations of those who bought very early and very low. he latter will begin to feel uncomfortably unsure of their position as soon as normal valuations are restored, or when the indications of overvaluation are first to be seen.
Of course, there’s also the very real danger that I’ll fall in love with BKL (what’s not to love about a profit approaching 200%?), something will happen, the price will fall and I will give up some or all of my gains on the position. What am I to do?
BKL looks expensive, but it may not be. It really depends on what happens to revenues and margins and both are impossible to predict with any certainty. So I will hold for it now but on one condition – I will sell as soon as it falls 10% from its 52-week high.
This way, I (hopefully) let my winners run while at the same time making sure that I’m not guilty of “thumb sucking” – as Warren Buffett calls it, if and when things change.
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