Hi I'm Jimmy in this video
we're looking at a great way to know
when to sell a stock for buy and
hold investors.
And the best part about this
investment approach is that it
allows for us to avoid the noise
in a stock much easier than we
may think.
So for this video I'm going to use a
real stock from a few years back
and I'm going to show you how
I use this particular investing
method and then I'll show you some
potential changes we can make to it.
Now in the name of full disclosure
this investing approach is actually
mine. I took it from guys like
Warren Buffett or Charlie Munger or
Peter Lynch.
All I did was took what they
were preaching and I put
into Excel and I came up with a good
way to try to
follow an investment without
being bothered by the noise.
OK onto our Microsoft example.
This is a real example of my
analysis of Microsoft back in 2016
for a friend's retirement account.
So it was intended to be a long
term investment.
And that's really important to
this whole investment approach.
It really only works if we're
intending to hold the stock for
at least a couple of years.
Now this is a classic buy and hold
Warren Buffett style of investing.
OK let's get started.
So the year is 2016 and
the third quarter just ended.
And here's what Microsoft's chart
looked like at that time.
Now this drop right here.
Well this happened because Microsoft
came out with earnings and analysts
were expecting 64 cents
in profit.
And in the actual number that was
reported was 54 cents.
Then we started seeing headlines
like this earnings decline
accounting methods blamed.
And profits fall by 25 percent.
And in the month after the earnings
were announced this is what the
chart looked like.
That's where the earnings were
actually reported.
And what was interesting about
all of the news that was coming out
about earnings was that
pretty much all the headlines said
that earnings were down big revenues
were down to flat.
But everything was pretty much a
variation of that.
But if we dug deeper will Microsoft
executives were coming right out and
saying this is the wrong way of
looking at it. In fact one Microsoft
executive said that on
a gap basis revenues
were down 6 percent but when they
adjusted for Windows 10 deferrals
they actually grew by 2 percent.
And if you adjusted for the
currency Well it grew by 5 percent.
Now I bring this up because I think
it's important that each of us let
our research stand on its own
ignoring mostly outside
information.
And just because everybody else is
screaming that earnings miss or
revenue miss or whatever it might be
we don't let that affect our stance
as long as we look closely at
the actual information.
OK so this brings us to when we
actually buy the stock so we jump
in we buy 100 shares of Microsoft at
about fifty one dollars per share
but before we do that we come
up with this.
This is the table that we create and
here I included 2014
and 2015 for historical reference
for the sake of the video.
But really what we're after.
In my mind is the projections.
Here we throw up the next five years
of projections and at that time I
just took analyst estimates and
basically what we cared about
was analyst estimates for revenue
for the next five years and then net
income margins I'd put in there what
they were expected to be.
Now this is important at the time
because this is how I was
calculating my fair value of the
stock. And at the time I was
calculating the fair value to be
about seventy seventy five dollars a
share.
But ultimately by
including net income margins and
revenue projections because
stock prices tend to
be highly correlated to
both the margins of the company
the profits of the company and
growth of the company.
So at this point 2016 when we buy
the stock the first three quarters
of 2016 were already completed.
Well as time goes by
another earnings number comes out
and this is what the chart looks
like from the day we bought this
stock up until the next earnings
announcement. So yes we're up and
it's been a bit volatile but do we
want to sell the stock now.
Well clearly the answer is No.
So I'm only gonna show two more
charts from Microsoft stock going
forward.
Basically we're gonna focus right
here because at the end of the day
this is the most important thing.
If we did nothing else but watch
this table I think we would do
perfectly fine.
So we had our first three quarters
already filled in and once
we got the new earnings from
Microsoft Well we filled in
both the revenue numbers and the
margin numbers.
And at that point
we can see that revenue
missed by about 400 million
dollars and margins came up by
2 percent short while we're in this
for the long haul so no worries just
yet. So time begins to pass
and we spend very little time
checking Microsoft's actual stock
price.
The only exception for that would be
as if we're looking to put more
money to work for looking to buy
additional shares.
But let's pretend we're not.
So we barely have to worry about
what Microsoft stock is actually
doing now in practice actually check
the news in the stock price about
once a week just so I can stay on
phone with the company.
So if the.
He has a big move.
Well it's likely to be tied to news
and that allows for me to challenge
my investment thesis which by
the way at that time investment
thesis for Microsoft was
focused on Microsoft's recent shift
from paying outright
for Office or Windows to
more of an annual subscription base.
Plus they had recently come
out with their surface products and
I was a huge fan of them at that
time. I thought that was a perfect
fit for their business model.
But either way let's pause right
here now.
This is after the first quarter of
Microsoft's 2019 number.
Now Microsoft has their year end
at the end on June 30th of every
year so the first quarter is
actually end of September of 2018.
Now this is important because
this is what the chart looks like
from the day we bought the stock
till Christmas Eve of 2018.
And as you may remember December was
a pretty rough month for the US
markets back in 2018.
Well how do we feel about Microsoft
stock now.
We bought the stock down here at
fifty one dollars a share it climbed
as high as one hundred and fifteen
dollars and since then it's
down almost 20 percent.
I'd hate to see this thing keep
falling.
Do we take profits or
do we want to stick in this thing
for the long run.
Picture the emotion that we're
feeling as we're watching
all of our profits roll away.
Well this is where I think it's
important for us to remember that
this is the wrong thing for us to be
looking at.
This can trigger very
interesting emotions when we're
investing.
Instead let's go back to our handy
dandy spreadsheet now.
This one is what we want to focus
on. Now if we look at this
revenue in 2016 missed
by about 400 million dollars
and the margins missed by about 2
percent.
Don't forget we want to compare
margins to our margin projections.
That's where I get that 2 percent
from then in 2017.
The mix was even bigger.
And when we jump over to 2018.
Well things started shifting in our
favor.
Revenue actually beat expectations
our expectations by six point
five billion dollars and margins
saw a small uptick although they're
not at our 26 percent price target
margin target just yet.
Now in 2019 we saw
that momentum continue.
When we look at each of the quarters
relative to each other.
Well things look pretty good.
Now this is true for each quarter.
So to me this is a sign of a solid
business. And it's actually why I'd
like to lay out this spreadsheet
like this. I want all the quarters
to be horizontal so we can compare
them to each other because if you
compare quarter to quarter Q1
from year to year pretty good
growth. Q2 good growth Q3
Q4. Same thing.
But if we to look at them
horizontally like this
well we might not realize that
the dip in Q3 is a natural
dip from year to year.
It could look a bit more volatile
when we go straight down from Q1
down to Q4.
Now this brings us to today and
ultimately the real question is when
do we sell a stock.
Well as buy and hold investors
I think it's key for us not
to be trying to gear up to sell a
stock too quickly.
I believe that the most appropriate
time to sell any stock for a buy
and hold investor is when
we find out that the reason
we bought this stock is no longer
in play and our outlook changes
in a meaningful way.
Often we can see that in the numbers
perhaps its margins perhaps its
quarterly revenue growth year over
year or annual revenue growth year
over year.
Perhaps the reason in this example
I believed that Microsoft switched
to the subscription model would
generate more revenue as management
was saying it was let's pretend
that's not materializing.
Perhaps getting out is a solid
move but it is a move based
on the fundamentals of the company
are exiting the position be based
on the fundamentals of the company
and not what the stock price is
doing. Now another good reason to
potentially sell a stock is that if
we have a better investment
opportunity somewhere else.
So I've heard a few people say
that you don't really lose until
you actually sell the stock.
And I saw this a lot around General
Electric over the past few years
as we saw the stock price tumbling.
And while yes this is true
from a tax perspective there
is also something to be said
for opportunity cost.
See had we sold out a jeep back
in this area well even if
we took a loss if we're putting
that money into an investment with a
better opportunity that we believe
has better long term prospects
that could also be a great move.
Now with the example of GE.
GE.
pretend that the reason we got
involved with General Electric was
because we believe that General
Electric's biopharma business was
going to be the thing that drove
them forward and then they go ahead
and they sell their biopharma
business. I recognize it into that
later but let's just imagine
if they had gone and sold that
and that was the reason we got
involved no matter what the stock
price has done we should reconsider
that investment.
Now perhaps they replace that with
a better opportunity and that
might be a good reason to stay.
But in my mind that is what
we're looking for a shift.
Our investment thesis or
the fact that the numbers aren't
materializing as we expected.
So the real answer for when to sell
a stock is we only want to sell
that stock.
If our long term outlook for the
company changes for the worse.
So watching revenues or profit
margins or free cash flow
or dividends per share are a good
way to gauge whether or not our plan
is working.
Now I also like to generally read
management's press releases after
earnings calls or their management
discussion and analysis from either
their quarterly filings or annual
filings. I think usually there they
do a pretty good job of discussing
the plan but only
if this stuff changes in a material
way. Is it worth getting out of a
stock if we're in it for
the high dividends and the company
suddenly cuts the dividend even
by a minimal amount.
Well that might be worth
reconsidering if this investment is
going to be good over the long run
but if we stick with a table like
this and this becomes our compass
to guide all future investment
decisions around this particular
investment well we can also
update this table whenever we want
and we can put in new numbers we can
extend them out further for future
years if we let this information
guide us then the day to day
noise of the stock price can often
be washed out by the overall
trend of the business.
So in the case of Microsoft.
Well when are we going to sell the
stock.
The answer is really not now.
It depends on what happens in the
future.
On December 24th
of 2018 we saw the stock crash
or a stock pullback pretty big.
I was perfectly happy just sitting
there it didn't bother me at all
because you and I know the overall
trend of the business.
We know it's going very well.
Don't worry about what the stock is
doing and I'm happy to
sit here for the next 20 years
holding Microsoft if their business
continues to perform.
So my question to you is
do you agree with this.
Is there anything that you would
have added to this whole process
that makes the whole thing a bit
stronger.
Please let me know in the comments
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Thanks.