Cut the flowers and water the weeds

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GUEST BLOG. I received the following question from a reader a few days ago. I take this opportunity to encourage you to send me your questions or to let me know about topics that you would like me to discuss in my next blogs.

Here is the question from PG:

I am in a dilemma right now. I am a long term investor and started on the stock market 5 years ago. This is not the first time that I am writing to you. I own shares of TFI transport which I bought for $ 36 and are now worth $ 141. For the first time in five years, I wonder if I shouldn’t take a profit by selling half of my shares or keep all of my shares in TFI for another 10 years. I have this hesitation because I read a lot of articles on profit taking. Basically, I wonder if profit taking applies for a long-term investor?

In my opinion, one of the popular expressions that have cost investors the most is this: “No one has ever lost money by pocketing a profit.

This quote seems to come from Bernard Baruch (1870-1965), an American businessman and politician who advised Presidents Woodrow Wilson and Franklin D. Roosevelt. You will certainly have heard it often from other investors, perhaps even your financial advisor.

If this quote sounds full of meaning, I seriously question it when it comes to the long-term stock investor. In fact, I much prefer the expression popularized by Peter Lynch, famous investor and author of the book “One Up On Wall Street“According to which”selling your winning titles to buy back your losing titles would be like cutting the flowers to water the weeds“.

On the one hand, potential stock returns are asymmetric. When buying a security, the potential return of that security is theoretically infinite while the potential loss is limited to 100% (unless you invest on margin). If, as an investor, you consistently sold every security that appreciated 50% or 100% from your initial cost, you would lose all of the long-term stock market advantage. Such a method reminds me of the general manager of a professional hockey team who would systematically trade in his best players to replace them with new draft picks.

On the contrary, I believe that an investor should rather “let run” his winners. It is only in this way that he will succeed in obtaining a few titles whose value will have been multiplied several times, what the Americans call the “10-baggers“, Or even”100-baggers“. Indeed, it only takes a few big winners in the life of an investor to make a marked difference in their long-term stock market performance. At COTE 100, we have been fortunate to have a few of these titles over the past many years. Titles such asFood Couche-Tard, CGI, Enghouse Systems, Visa, Accenture Where Berkshire Hathaway have rewarded us greatly and have contributed to our returns over the years.

That said, you shouldn’t keep your winning titles indefinitely without ever questioning them. As part of our management, we have established a discipline of developing an initial buy scenario whenever we decide to invest in a new security. This scenario sums up our in-depth analysis in a few lines and summarizes the reasons that, in our opinion, make a security a purchase. Once the security has been acquired, we monitor it at least every quarter when the company’s quarterly results are published. It is also an opportunity to make sure that our scenario is still valid; otherwise, we will choose to sell the title.

During these updates, I also recommend adjusting your rating of the title based on the most recent results and developments. If the security’s price significantly exceeds your valuation, you may want to reduce your position somewhat. Over the years, we have learned that it is indeed better to reduce a position in a security that we believe has become too expensive rather than sell it in full.

Another reason for reducing an investment is to manage the risk associated with a position that becomes too large in a portfolio. In my opinion, it is this exercise that the author of the above question should perform in relation to the title of TFI transport, formerly known as Transforce.

In short, I recommend a two-tier patience: you have to be very patient with the securities of companies that deliver excellent financial results and be rather uncompromising with the securities of companies whose financial performance leaves something to be desired.

Philippe Le Blanc, CFA, MBA

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