Three Longs & Three Shorts

The Art of (Not) Selling

Author: Chris Cerrone
Source: Akre Capital Management (

Whilst there are many privileges to being a Marcellus employee, one of the most tragic aspects of our job is watching hard working Indian families indulge in an illness called “profit taking”. As per this misguided school of investing, if your investments have done very well recently, you should “take some profits off the table”. Chris Cerrone, fund manager at Akre Capital, a 30 year old American mutual fund based in Virginia, has written a super piece on the uselessness of this activity i.e. selling or taking profits. Mr Cerrone says:
“Of our most costly mistakes over the years, almost all have been sell decisions. The mistake, in virtually every instance, has been selling too soon. Reflecting on these mistakes gave rise to this letter, and its title, “The Art of (Not) Selling.”
Taking a step back, our investment philosophy involves concentrating our capital in a small number of what we believe to be growing and competitively advantaged businesses. These kinds of businesses are rare and are only periodically available for purchase at attractive valuations. With that in mind, we do our best to hold on for the long term, so that our capital may compound as the businesses grow.
Holding on means resisting the temptations to sell — and there are many. We tune out politics and macroeconomics. To the surprise of many, neither valuation nor price targets play a role in our sell decisions.
To be clear, there may be times when we believe it is appropriate to sell. In these instances, it is typically because of an adverse change in the business itself.
This determination to hold on is a critically important, and not always well understood, aspect of our investment philosophy. At its core, it relates to the power of compounding. We believe these two ideas — (not) selling and compounding — are inextricably linked. Getting the first wrong makes the second impossible. Allowing our investments to compound uninterrupted is our North Star.”
Rather than them preaching the merits of long term compounding (as fund managers usually do), Chris then gives a cleverly thought through and counterintuitive mathematical example how damaging it can be to “take profits”:
“You are given the choice between two sums of money: one million dollars or a penny that will double every day for 30 days. Which should you choose?
Here are a couple hints. The penny that doubles daily would be worth $1.28 after the first week. After the second week, it would be worth $163.84.
You will probably reason that the penny would be worth more than the one million dollars. (Why, otherwise, all the theatrics?) By just how much, though, might surprise you.
It turns out that after doubling 30 times, the penny would be worth $10,737,418.24!
This is a terrific exercise because it highlights the not-so-obvious power of compound returns (in this case, the penny compounds at 100% for 30 periods).
I say not-so-obvious because you would have been better off taking the one million dollars until the 27th day. But in those final four days, the value of the penny increases from less than $700,000 to more than $10.7 million. Patience and a long-term perspective are required to give the power of compounding an opportunity to do its magic….From this riddle, we learn the importance of holding on so that we allow our investments to compound uninterrupted for long enough that the compounding effects we saw in days 27 to 30 have an opportunity to play out in our portfolios.”
Chris then explains that political events, economic developments and valuations – the 3 most commonly cited reasons for selling stocks – are all irrelevant for investors:
“We have learned to be very careful about the reasons we sell. We try hard to tune out concerns about politics and the economy. We read the newspapers, and we work just down the road from Washington D.C. However, it has been our experience that we are at our worst as investors when we allow concerns about these issues, including elections, trade wars, and Fed policy, to influence our investment decisions.
In addition, we try to resist the temptation to sell (or trim, even) on the basis of valuation alone. We are unfazed when our businesses are quoted in the market at prices above what we would pay for them. It might be worth reading that last sentence again for emphasis.
Why? For three reasons…
First, when selling because of valuation, it is often with the idea that there will be an opportunity down the road to buy back in at lower prices. In our experience, it seldom works out this way.
Second, of the thousands of publicly traded companies, there are probably fewer than one hundred that meet our criteria, and opportunities to buy them at attractive prices are few and far between. Unlike average businesses that can be traded like-for-like on the basis of valuation alone, growing and competitively advantaged businesses are just too hard to replace.
Third, the very best businesses tend to exceed expectations. What may seem like a high price today may be proven to be perfectly reasonable in hindsight….Valuation plays no role in our sell decisions, and neither do price targets.
The underlying idea behind a price target is that every business has an intrinsic value and that the goal of an investor should be to buy at a discount to intrinsic value and sell when the discount has narrowed. It is compelling to say that you buy proverbial dollar bills for 60 cents and sell them later for a dollar.
With growing, competitively advantaged businesses, however, that proverbial dollar bill may be worth a dollar now, but we expect it will be worth $1.20 next year and $1.40 the year after that. When in possession of these kinds of businesses, we believe that you are much better off holding them for the long-term and allowing them to compound.”