When to sell: XP Power edition
The loneliness of the long-distance contrarian
If you think it's tricky buying shares everyone else wants to sell, you should try selling one everybody else wants to buy! XP Power (XPP) has done everything right and made the Thrifty 30 money, yet I've removed it from the portfolio and added International Greetings, which may just be wheezing back to life.
So why XP, and why now?
I've spent most of this year adding shares having, started last September with an empty portfolio and space for 30.
Buying Thrifty-style is a two stage process: Screening for companies that are cheap and strong, and trying to weed out the value traps, companies that look cheap, but may be in permanent decline. Typically they face obsolescence, have hidden liabilities that could sink them, or a predatory shareholder engineering a de-listing.
I've been looking for companies that don't need a get out of jail free card to surprise investors, they just need do stay listed, keep costs down and sell more stuff.
Selling is simply the opposite. I plan to remove companies from the portfolio when:
- They're no longer cheap
- Their financial position has weakened
- I've changed my mind, and think the company is a value trap.
Armed with selling criteria, the difficult bit is remembering to apply them. Monitoring shares every day is time consuming, and makes you unhappy nearly half the time. Nassim Taleb demonstrated the mathematics in his book, Fooled by Randomness. He calculated the probability a very successful investor will make money in any one day is 54%. The probability he will make money in any one year is 93%. Better not to dwell on the daily performance then.
Statistically, value investments pay off over many years, so there's no sense in fretting about day to day fluctuations in share prices. Based on calculations by James Montier, and Benjamin Graham, the inspiration for the portfolio, as well as an academic paper 'Time and the payoff of to value investing' I recently discovered among UK Value Investor's 'must reads', I'm willing to wait five years for my minimum return of 50%. This chart from a research note Montier published in 2008 shows why:
It compares the returns of the cheapest 20% of global companies according to a variety of measures against the most expensive 20%, after deducting the market return. After four years the average value share had returned 33% more than the market. So value shares are worth hanging on to.
Rather than buy and hold for a set period, I sell when a company rises in price and loses its value potential and re-evaluate each company periodically to ensure it still deserves its place in the portfolio.
To make sure I remember, without following each company fanatically, I set an alarm to notify me if one of the Thrifty 30 members rises above 50% of the price I added it. Websites like the Interactive Investor mothership and software like Sharescope allow you to do this. I also re-evaluate the finances and business of each company annually, when it publishes its annual report.
When I showed a draft of this blog to Dr Keith Anderson, whose extreme value portfolios I write about, he said:
I find your trading rules annoyingly vague, but then that's because as a former computer programmer I'm drawn to a clear quantitative set of trading rules.
Fair enough, I hadn't said at what level I determine a company is no longer cheap, or how I decide it's financially weak, and that's because I exercise judgement, within certain parameters. So let's specify those parameters: If the company is emerging from a period of serious trouble and has not been earning good profits I might remove it once it achieves, say, a long-term PE of 10. If however, like XP it's consistently profitable, say its return on total assets has been over 10% for the last five years, I might chase it all the way up to 20. Likewise an F_Score of less than five out of nine would more than likely prompt a sale, but I would check each of the nine indicators to ensure I 'm not ejecting the company for a spurious reason.
So far I've removed three companies from the portfolio: OPD because it was a value trap and Chime because I lost confidence in my original analysis, I wasn't sure if it was cheap, or financially strong. Two weeks ago, before I went on holiday, I also removed XP, this time for the much more satisfying reason that it was no longer obviously cheap.
After XP published half-year results, the latest in a long run of good news, the shares shot through the 50% profit point (the portfolio made a 68% profit). They'd only been in the Thrifty 30 four months.
I added XP when it cost 13 times earnings averaged over the last six years, more than I like to pay, but I thought it was worth it because the statistics: rising earnings, steady profitability, and debt repayment, validated the company's claim that control of costs and quality since it started manufacturing its own power adapters, was driving growth.
The results confirmed it, but the shares now cost 22 times the average of the last six-years of earnings or 19 times last year's, and at that level I don’t think XP is one of the best 30 investments I can make, though it’s obviously a good company.
Earlier this month, founder and deputy chairman James Peters sold 200,000 shares, or 1% of the company, at £7.35. I wouldn't read too much into this. He still owns 14%.
Nevertheless, I’ve defied conventional wisdom about running profits and cutting losses by removing a proven winner from the portfolio and ploughing the money into a proven loser.
That's what it means to be contrarian.
When cash burn is good
According to the Psy-Fi Blog "Forecasters are signing their death certificates every day," and one day they will be right.
Stanford professors work out how to tell when a chief executive is lying.
Saj Karsan on when cash burn is good, or not bad at least.
Ten investment rules I can agree with, originally from Ian Rushbrook.
John Mulligan's more of a contrarian than me. He's added HMV to his income portfolio.
Think your boss is bad? Read these memos from Tiger Oil’s ceo in the 1980’s: “I want to save my throat. I don't want to ruin it by saying hello to you sons-of-bitches.”
About the author
Richard is companies editor of Interactive Investor and a columnist at Money Observer magazine. A keen private investor through his Self Invested Personal Pension, he manages two virtual portfolios. The Share Sleuth portfolio is a hand-picked collection of mostly small-cap value shares, while the Nifty Thrifty is a mechanical portfolio designed to pick large, successful companies at cheap prices.
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