How Long Should You Hold on to Your Winners?

Last Monday was Teachers' Day and the Tuesday before that was Warren Buffett's 92^nd birthday.

It is quite fitting that barely a week after Buffett's birthday, we pay tribute to one of the finest teachers of investing the world has ever known.

Buffett has not once shied away from sharing the secrets of money-making as candidly as they can be shared.

Be it investing or life in general, his timeless wisdom is all out there for anyone to learn and imbibe. He has been as selfless as they come.

Apart from investing intelligently, this is another attribute that Buffett seems to have picked from his teacher, Ben Graham.

We all know that Ben Graham was also quite magnanimous in sharing his knowledge and wisdom.

In fact, I absolutely love this passage by Warren Buffett where he pays tribute to his teacher.

I knew Ben as my teacher, my employer, and my friend. In each relationship-just as with all his students, employees, and friends-there was an absolutely open-ended, no-scores-kept generosity of ideas, time, and spirit. If clarity of thinking was required, there was no better place to go. And if encouragement or counsel was needed, Ben was there.

Walter Lippmann spoke of men who plant trees that other men will sit under. Ben Graham was such a man.

The reason Buffett is so enamoured by Graham is because Graham taught him three principles that as per Buffett's own admission, are hugely responsible for his stupendous success.

Had it not been for these principles, Buffett perhaps wouldn't have been the multi-billionaire investor that he is today.

Well, here are the three principles that shaped Buffett's investment philosophy.

• Think of stocks as part ownership in businesses and not some symbols that you see on ticker tapes.
• Think of the stock market as this moody, temperamental fellow who is at times greedy and at times, fearful. Buy from him when he is fearful and sell to him when he is greedy.
• And last but not the least, always buy after considering a proper margin of safety.

That's it. Only three principles and quite simple ones at that. As someone has rightly said, investing is simple but not easy.

Anyways, where is the rule of selling here?

Shouldn't there be a fourth principle about selling? To be more specific, a principle about how long should you hold on to your winners or how long should you wait before you come out of a losing stock?

Yes, there should be a principle about the important aspect of selling but it seems to be missing from Graham's text.

I've read both the landmark works of Graham i.e. The Intelligent Investor and Security Analysis.

In fact, I have read them many times over and still don't recall coming across a detailed discussion on 'when to sell your stock'.

It is as if Graham believed in the principle that one should not count on making a good sale. One should have the purchase price to be so attractive that even a mediocre sale brings good results.

While the idea of not counting on a good sale is certainly good, we need something more tangible. Something that's more concrete and can be applied in the real world.

Value Stocks: For People Who Never Like Overpaying for Anything

So, if Graham has not given specific guidelines on selling, let us try and deduce it from his writings.

As you are aware, Graham is all about trying to figure out a fair value or an intrinsic value of the company.

Therefore, it can be quite reliably concluded that you buy a stock at a discount of at least 30%-35% from its intrinsic value and sell it when it reaches this intrinsic value.

If the intrinsic value of a company is Rs 100, buy it at Rs 60 or lower and then sell it when it reaches Rs 100 anytime over the next 1-2 years.

So, this is one of the principles that you can use for selling your winners.

In fact, I have been following this rule and quite successfully at that for both my services i.e. Microcap Millionaires and Exponential Profits.

Here, a stock is recommended only if it is trading at a 25%-30% discount to its intrinsic value and then exited from after a gain of 50%-100% or two years, whichever is earlier.

Therefore, in a nutshell, you buy at a discount, wait till it goes up 50%-100% over the next 1-2 years and then sell. If it doesn't, you still sell and move on to some other stock.

Once again, a very simple principle, but as I mentioned earlier, not easy to follow in real life.

Now, there's a small problem here. Graham's rule of selling or rather his deduced rule of selling assumes that intrinsic value is largely static.

Therefore, it works only for those companies where earnings have stagnated or are growing at a very slow pace.

However, what about those stocks where the intrinsic value is not static but is growing year after year because of the growth in earnings. What do we do in such cases?

Well, here we need to turn to Graham's most famous student i.e. Warren Buffett who developed his own rule of selling during the latter half of his career.

Buffett observed that there are some businesses that are so good quality that they never stop growing their intrinsic value. As long as there is inflation in the world, these stocks will keep growing their earnings and in turn, keep growing their intrinsic values. They are true blue multibaggers stocks.

Therefore, if you get hold of such a stock at an attractive valuation, you should never sell these winners.

Yes, you heard that right. Your holding period for such winners should be forever.

And Buffett has walked the talk on this. There are stocks in his portfolio that he has been holding for 30-40 years now and has no intention of ever selling them. As per Buffett, these are the gifts that will keep giving.

So, here's the entire piece so far in a nutshell.

It helps to develop a selling rule for your winners if you divide them into the ones where the intrinsic value is static and the ones where it will continue to grow for many years into the future because of the special quality of the business. For the first kind, you sell after a gain of 50%-100% or two years whichever is earlier.

And for the second, don't ever sell them as long as the business quality is intact.

Now there are a lot of variations between these two extremes that you can play around with. And you can certainly develop your own selling rule provided it has a sound logic to it, you are consistent in applying it and has worked for you in the real world over at least 5-7 years.

If the answers to all these questions is a big 'yes' then you can certainly follow your own selling rule without worrying about how others think and react to it. For others though, the guidelines I just shared can come in handy.

Warm regards,


Rahul Shah
Editor and Research Analyst, Profit Hunter

PS: While we are on the topic of winners, Tata Elxsi has certainly been one of the big winners of the current bull market. But what next for this high-quality stock? Should one continue to hold on to it or is this a good time to exit? Check out my latest video to know more.