When To Sell Stocks, According To Warren Buffett
"Our Favorite Holding Period Is Forever" - What Did Buffett Really Mean?
“Our favorite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds.”
―Warren Buffett, Berkshire Hathaway Letters to Shareholders
The 6 "Notices" (see below):
1. Notice how it's about risk-first, profit-later?
2. Notice how it organically results in a long-term investment horizon?
3. Notice how it makes investors chase very different stocks?
4. Notice how it renders market volatility irrelevant?
5. Notice how it makes investors purely focused on fundamentals?
6. Notice how it demands a very large Margin of Safety (because he can't sell)?Buffett is quite well-known for his quote above about “when to sell”. At first glance, this makes sense. Anyone who is familiar with Buffett will know that he tends to buy and hold his successful positions without selling them1 — e.g. he has held onto Coca-Cola since 1989, and more recently has held onto Apple since 2016.
However, many value investors get stumbled by the subsequent implications of such an investment approach. If one buys and holds forever, how do they enjoy their returns? Surely profiting from dividends alone isn’t ideal, right?
It may surprise readers to discover that Buffett’s quote above actually has plenty of incredibly complex subtext, both for holding periods as well as how to think about stocks. In this article, I’ll unpack them for the hungry acolytes attending the school of Graham & Doddsville.
“When Should You Sell?”
Most people think about stocks as pieces of paper — i.e. acquire them for a price, hold onto them for awhile, and then sell them later for a profit. Even value investors tend to think this way, albeit over much longer timeframes.
What Buffett actually means by “our holding period is forever” is to genuinely consider stocks as pieces of a private business. I know this sounds unbearably cliché, but really think about what that means. It just means what I’ve implied above — that Buffett only intends to realize his gains via dividends or share buybacks (i.e. total shareholder return).
While this is something easily understood on the surface, the actual implications of such a methodology are harder to embrace. For instance, think of the hedge funds across the world who would balk at such a rigid approach. How does one even run a fund with a rule of “never selling”?
What happens if the investee business deteriorates? Does the fund manager simply dogmatically stick to his principles, and risk going down with the ship? Where are the boundaries for this principle drawn, and at which times is it okay to forego the rule?
As aforementioned, Buffett’s holding period of “forever” implies that he only intends to realize gains from dividends and buybacks. That simply means to treat the stock investment as buying shares in a private business.
To be clear, this is indeed how most value investors frame their investment decisions — where valuation is purely a function of underlying profits. However, Buffett’s quote seems to go deeper than that. He isn’t merely saying that valuation should purely be a function of fundamentals — his quote implies literally recovering your capital via dividends and buybacks alone, without ever selling the stock. This is where I think the majority of self-identifying value investors and Buffett himself would go down separate paths.
Consider two value investors: one who buys a stock planning to flip it after 5 years; and another who buys a stock planning to never sell it. Ever. What would be the differences in attitude that both would have when buying stocks?
Firstly, while the former may very well intend to hold his stock for ultra-long periods by most respects, he still has an escape path should things turn sour. This means that he would likely have a higher risk threshold than the latter — in the worst case scenario, he can still sell and get out of the position to recover some of his capital.
Meanwhile, the latter investor understands that if he buys a stock and it fails, he goes down with the ship. Notice how this is a risk that most investors wouldn’t even think about? If the investor has to consider the possibility of being handcuffed to a sinking ship, he’d likely demand a much larger Margin of Safety, right?
This is also where Buffett’s quote “the trick is, when there is nothing to do, do nothing” becomes highly relevant. A practitioner of such an investment philosophy is going to find very few stocks that meet his significantly higher-than-normal risk criteria. One might only come across 1-2 stocks per year that fits the bill.
To clarify, when I say “risk”, what I mean is the permanent loss of capital, not business risk. As I’ve explained in last week’s article, it is possible to buy a significantly undervalued stock and not experience any loss even if the business subsequently deteriorates — as such business risk had already been priced-in. Hence, just because a business appears risky on the outside, that doesn’t automatically equate to capital risk (and vice versa).
The 6 “Notices”
1. Notice how it's about risk-first, profit-later?
2. Notice how it organically results in a long-term investment horizon?
3. Notice how it makes investors chase very different stocks?
4. Notice how it renders market volatility irrelevant?
5. Notice how it makes investors purely focused on fundamentals?
6. Notice how it demands a very large Margin of Safety (because he can't sell)?
As aforementioned, most investors think of profiting from stock investments as reselling a stock at a higher price for capital gains. This usually involves some hazy, intangible estimation of valuation multiples in the future — or an equally ethereal comparison to peer multiples.
While this is a legitimate approach to valuation, it’s ultimately a mystical art with no well-defined rules. If you’d like to test it out, ask an analyst who came up with their comp-based valuation to put their money where their mouth is — and watch their reaction.
In contrast, most analysts tend to widely agree on how to estimate future profits. This is because profits exist in the tangible world, and are constrained by real-world “rules” which form the boundaries of our imagination. While the estimation of profits are ultimately subjective, their estimations are subject to significantly less abuse than multiples are.
However, when investors are forced to think about a future exit price, that invariably involves an estimate of future exit multiples. This is where you get hazy justifications like “10x PE for no-growth” or peer multiple comparisons — which begs the never-ending infinite “why?”. Add in a sprinkle of macro volatility, and that’s a recipe for hubris in valuation.
Now let’s consider how Buffett would approach valuation instead — based on his quote above, “our favorite holding period is forever”. That implies that he never intends to sell, right? Subsequently, wouldn’t it also mean that he wouldn’t have to estimate an exit multiple?
As aforementioned, Buffett is actually more interested in recouping his capital via business profits over time rather than by selling the stock — this ultimately boils down to dividends + share buybacks. This is why it’s called “RETURN of capital” — it’s the company returning the investor’s investment, in the form of profit distribution.
Let’s pause here and consider the implications of adopting such an investment process. An investor who truly practiced such an investment process would end up choosing VERY different stocks, right? Since he only intends to recover his investment via profits, he would first and foremost be highly concerned with the price paid for the investment relative to profits (i.e. multiples).
While this doesn’t preclude high-multiple stocks if sufficiently high growth can be justified, it does motivate the investor to prioritize recovering his capital before even thinking about profiting from his investment. This is in stark contrast to the behavior of most stock market participants, which is to consider profit first.
Firstly, notice how this a a risk-first narrative, as opposed to a maximum profit narrative? At the risk of repeating myself, someone who truly intends to recover his investment via business profits alone would most certainly prioritize recouping his capital before thinking about gain. In fact, this is exactly how most M&A operators behave — it’s just normal business logic.
Secondly, notice how having such an investment mindset organically results in a long-term investment horizon? If you truly cared about recovering your investment only via business profits, you would automatically have an investment horizon spanning 10-20 years at a minimum. Anything earlier than that tends to be a bonus.
Thirdly, notice how such an investor would be chasing remarkably different stocks than the ones which get most market participants excited? Consider something like GM, which David Einhorn has been invested in for the better part of the past decade — and which has stayed at single-digit multiples the entire time. BORING, right?
However, after including dividends, I bet Einhorn managed to get his 15% required annual return on the GM investment while assuming miniscule risk. What percentage of Bitcoin or Tech megacap “HODL-ers” can truly say they beat his performance over the past decade?
Fourthly, notice how such an investment approach renders market volatility completely irrelevant? If an investor only cared about recovering his investment via business profits, would he really worry about daily fluctuations in the stock price? As long as it doesn’t affect the business — and it usually doesn’t — who cares what the stock price is at any given day?
This goes back to what Buffett was saying about not monitoring stock tickers. Since he only cares about business profits, whatever the stock price does is truly irrelevant to him, despite Buffett obviously being capable of assessing macroeconomics. This goes back to another quote of his — the about not knowing what the stock price would do tomorrow, a week from now, or a year from now.
Fifthly, notice how such an approach automatically makes Buffett truly an investor in purely business FUNDAMENTALS? I think this part is self-explanatory — if one only cares about recouping the investment via business profits, they shouldn’t really mind what the stock price does from day-to-day.
And finally, notice how practicing Buffett’s investment approach demands a very large Margin of Safety — since the value investor’s never intends to get out of the position? We’ve already covered this above.
Lesson: Only Expect To Breakeven From Profits
This is what Buffett means by having a holding period of “forever” — it means to only ever expect to breakeven on the stock investment from business profits. Some might say that I am simply referring to the PE ratio — but rather than expect to sell the stock at a higher stock price, value investors should only expect to get their capital back from profits/EPS! Given such a constraint, doesn’t that significantly change your attitude towards stocks?
As a true-blooded value investor who took such a long time to arrive at such insight, I can testify without a shadow of a doubt that understanding what Buffett really meant has changed how I invest. Not only because it gave me such a stark form of competitive differentiation in terms of how I invest — in a way that barely any competitors (i.e. other market participants) will bother to replicate — but because it feels like something I can truly put it into real-life practice to grow my personal wealth.
And now that you’ve read this article, hopefully you feel the same way too!
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Disclaimers:
Disclaimer: This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein or of any of the authors. To the best of the authors’ abilities and beliefs, all information contained herein is accurate and reliable. The authors may hold or be short any shares or derivative positions in any company discussed in this document at any time, and may benefit from any change in the valuation of any other companies, securities, or commodities discussed in this document. The content of this document is not intended to constitute individual investment advice, and are merely the personal views of the author which may be subject to change without notice. This is not a recommendation to buy or sell stocks, and readers are advised to consult with their financial advisor before taking any action pertaining to the contents of this document. The information contained in this document may include, or incorporate by reference, forward-looking statements, which would include any statements that are not statements of historical fact. Any or all forward-looking assumptions, expectations, projections, intentions or beliefs about future events may turn out to be wrong. These forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks, uncertainties and other factors, most of which are beyond the authors’ control. Investors should conduct independent due diligence, with assistance from professional financial, legal and tax experts, on all securities, companies, and commodities discussed in this document and develop a stand-alone judgment of the relevant markets prior to making any investment decision.he does sell small amounts from time to time, but rarely entirely liquidates his successful positions.
This was a good one to read.
It also might be worthwhile to point out that Buffett says that his *favorite* holding period is forever. Just following the logical bread crumbs you've laid out very well here, it's easy to see that "favorite" and "only" aren't remotely close to the same thing.
I think people (myself included) have tended to read Buffett's quote as "only", but that's definitely not what it says.
Thanks for posting.
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