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The Daily Reckoning | Saturday, April 14, 2012 Buying low is only half the equation: In search of a better exit strategy, Does US real estate have a place in your permanent portfolio? Plus, all the week’s reckonings, archived for your non-perishable enjoyment... --------------------------------------------------------------- The Opportunity to Change Your Life This is one of those rare opportunities to you have to change your life...  One off-the-radar company, priced under $4 per share, is sitting on estimated oil reserves that could power the US for more than a year.  This company’s stock could soar and still be grossly undervalued. Wall Street won’t ignore this situation for long, click here for the full report. Joel Bowman, checking in today from Buenos Aires... Joel Bowman Even people who weren’t paying attention this week would have had trouble missing the launch of Chris Mayer’s new book, World Right Side Up. Such was the buzz it created around the Agora Financial offices, near and far. Here’s Laissez-Faire Books executive editor, Jeffrey Tucker, interviewing Chris during the “Digital Book Launch” on Thursday. (To view it, simply click the image and follow the instructions on the next page. You will automatically be signed up to receive our new Laissez Faire Todaynewsletter and have exclusive access to a very special offer.)  Of course, without the investor component, travel investors are little more than wandering gypsymen, ambling hither and thither with no particular aim in mind. Perish the thought! In this week’s feature essay, Chris Mayer proves his investor stripes with an answer to a very important reader question. Please enjoy... [This essay was originally published in these pages on April 11, 2012] The Daily Reckoning Presents The Art of Selling Stocks Chris Mayer I got a question from a self-described “loyal reader” of Capital & Crisis. I began to answer it, and my response turned into a mini- treatise on the art of selling stocks. Here is the question: “Chris: I see a remarkable contradiction in your latest issue of Capital & Crisis. At the outset, you extol the virtues of [the successful investor Thomas] Phelps, who was an advocate of buy right and hold long, with the rest of your strategies, which seem based on sell half, take profits, and let the rest run. As you publish the bookkeeping on how long you have to stay in on an initial investment, undisturbed, to make a big profit at a given rate of return, why not make an equal effort to bookkeep what happens to your initial investment and final returns when you take half out every time it doubles? Let’s see what it makes you or costs you to do it that way. It seems to me that the take-profits approach is an admission of a lack of confidence in self or the company, but somehow feels like falling down stairs every time you almost reach the top.” Fair questions. Let me start by saying that selling is the hardest thing to do well as an investor. I don’t think anyone does it well consistently, and that includes the whole slew of investing greats — past and present — that I’ve studied. Everyone has sold something only to see it rise higher. And everyone has held onto something only to give back lots of apparent gains. Second, remember that Phelps didn’t say hold onto stocks blindly. He wrote: “My advice to buy right and hold on is intended to counter unproductive activity, not to recommend putting them away and forgetting them.” Now let’s talk about taking partial profits. At Capital & Crisis, I don’t automatically advise selling half when a stock doubles. I’m against mechanical rules of all kinds. I use our judgment. When a stock is fully valued or close to it, I tend to let it go — or at least a part of it. That’s often the case after a quick double or so. If it is still undervalued, I tend to keep it. Canadian Natural Resources (NYSE:CNQ), for example, has doubled twice for my subscribers over the time I suggested buying it. But I have never suggested taking any money off the table. This is simply because CNQ has tremendous assets in the ground, and I don’t think the stock has ever fully reflected that value. Another example: Ensco doubled, but I did not suggest selling half. Instead, I suggested closing out the entire position for a 132% gain after it made a big acquisition I didn’t like. Sometimes, selling half is costly, as you say. Selling half on GTLS looks like a bad idea now — I suggested selling half the position for a 112% gain, and the remaining half is up 203%! Other times, selling half looks smart. I suggested selling half of Northwest Pipe, booking a 120% gain. Eventually, as circumstances changed, I recommended selling the rest of the position. But by that time, the stock had fallen to a much lower price. Even so, both sells looked pretty decent in hindsight, as the stock remains below the lowest level at which I recommended selling, and overall, that investment booked a healthy gain of 65%. Other great investors follow similar approaches. The late Peter Cundill, for example, was a great investor who was a fan of taking half of a position off the table after it doubled. The book to read is There’s Always Something to Do: The Peter Cundill Investment Approach by Christopher Risso-Gill. In the book, there is the story about how Cundill bought Tiffany & Co. for $11 and sold it when it hit his valuation estimate ($19 per share) a year later. The problem was that six months later, it got a bid for $50. As Risso-Gill writes: “This outcome prompted considerable discussion among the Cundill Value Fund board members over the question of how to deal with the problem of when to sell. Peter himself could come up with no absolutely satisfactory proposal or formula. In the end, the solution turned out to be something of a compromise: The fund would automatically sell half of any given position when it had doubled, in effect thereby writing down the cost of the remainder to zero, with the fund manager then left with full discretion as to when to sell the balance.” Cundill later expressed it this way, “When a stock doubles, sell half — then what you have is a free position. Then it becomes more of an art form. When you sell depends on individual circumstances.” I think this is a reasonable approach and seems to navigate that treacherous corridor between fear and greed, between risk and reward. I don’t think such decisions should be automatic, but you should think about selling when valuations are full. A good case study of failing to sell part or all of a fully valued stock is in the latest quarterly letter of the Third Avenue Real Estate Fund (TAREF), managed by Michael Winer and Jason Wolf. It was a good letter, and I respect the managers for admitting and discussing their error. TAREF owned a big position in Forest City Enterprises. It was a terrific investment for the fund. Over the 10 years ending Sept. 30, 2008, Forest City delivered a return of 16.7% annualized. However, for the three years ending Sept. 30, 2011, the stock generated an annualized loss of 29.4%! Messrs. Winer and Wolf write: “After 10 years of providing shareholders with stellar returns, most of those returns have been given back... So what happened?” Lots of things changed with the company over that span, as you might imagine, and they discuss them. But Winer and Wolf conclude that they made a mistake not trimming the position in 2006 and 2007. “The stock traded at all-time highs, and it became more difficult to justify the stock price without stretching our valuation estimates.” Because of this experience, they have adopted a revised approach. This includes being “more proactive in reducing and/or eliminating holdings based on price appreciation or to reallocate into securities with more-attractive valuations.” Winer and Wolf sum up: “These proactive portfolio adjustments do not represent a change in fund management’s fundamental approach to analyzing businesses and the prices of their securities, nor does it mean that we are now engaged in ‘market timing.’ We time our entry and exit from securities positions based upon fundamental valuations, not on expectations of price movements in the market.” I think that is well said. And it’s essentially how I think about the problem. In the end, what you want to do is go in as a buy-and-hold investor. You want the effects of compounding to work for you, as well as the favorable tax treatment that goes along with buy-and-hold. So I think it is important to enter every new investment with a buy-and- hold mentality. Even modest rates of return pile up to extraordinary heights over time. But you also want to be alert to when your thesis is no longer true. Back in May 2005, I visited Ralph Wanger in Chicago. Wanger, if you don’t know, was another great investor. He led the Acorn Fund to market-beating returns over a 26-year stretch. He spent two hours with me, just talking about his philosophy of investing. I loved it and included my summary of the interview in my first book, Invest Like a Dealmaker. Wanger’s sell discipline was pretty simple: Sell when your reason for owning the stock is no longer true. This is probably my favorite reason to sell. When the main thesis for owning the stock vanishes, it’s often a good time to go. If a great balance sheet is one of the reasons you own something, for example, and it does a deal that makes the balance sheet weak, then it’s time to go. Or if you bought a stock because of a big gap between the stock price and NAV and that gap closes, then it’s time to at least think about selling. There are also portfolio considerations to think about. If I need to sell something cheap to buy something cheaper, then I will. Some regular trimming is good, I find, to stay invested in the best and most-convincing ideas. This makes evaluating selling hard, too, because maybe what I sold continued to do well, but maybe what I bought did a lot better. So this is a long answer. But believe me; I’ve given the art of selling a lot of thought. I track every sell I’ve ever recommended to my subscribers, with the idea of trying to learn something from it. The bottom line: There is no magic way to sell to ensure maximum gains every time out. I think anytime you sell, you could cost yourself money if that stock turns out to be a big winner. I understand that risk. On the other hand, as Third Avenue shows, there are also risks in getting too complacent about a holding. When the market gives you a great price to sell, you should be willing to at least think about reducing your position. As long as valuations remain reasonable, though, you may hold a stock indefinitely as the stock and the value of the business grow together over time. Also, we don’t have to be perfect in holding onto everything we buy in aiming for Phelps’ 100-to-1 returns. The main idea is to know how those big returns happened and what investors had to do to get them. Phelps summed it up best. “Just as a slight change in a golfer’s grip and stance may improve his game, so a little more emphasis on buying for keeps, a little more determination not to be tempted to sell... may fatten your portfolio. In Alice in Wonderland, one had to run fast in order to stand still. In the stock market, the evidence suggests, one who buys right must stand still in order to run fast.” Regards, Chris Mayer,  for The Daily Reckoning Joel’s Note: Wanna grab three free trial months to Chris’ Capital & Crisis? Jeffrey Tucker revealed the details in his recent interview with Chris, which you can still catch by signing up for our new Laissez Faire Today newsletter. We’ll leave it up on the site until Monday. Just click here, and follow the instructions on the page. World oil production is about to be shaken to its core... You won’t believe which nation analysts at Wall Street’s biggest banks expect to become the world’s biggest energy producer by 2017 — or the effect it will have on America... our economy... our future... Click here to see who is set to become the new king of oil — and how you can use the news to go for big profits as early as this MAY! ALSO THIS WEEK in The Daily Reckoning... A Case of Cult Envy By Eric Fry Laguna Beach, California Today, we examine two cults — one with a charismatic leader and millions of disciples; and one with no leader whatsoever, but billions of disciples. Neither cult engages in fringy activities like polygamy, sacrificing goats or building armed compounds in the desert. Nevertheless, both cults attract a very fanatical following. Today, we examine the cult of Berkshire Hathaway and the cult of gold-buying. The former pays homage to Warren Buffett; the latter genuflects at the altar of Hard Money. Should We Worry about the Class Divide? By Jeffrey Tucker Auburn, Alabama  Charles Murray’s new book Coming Apart has generated an incredible amount of hand-wringing on all sides. For those who are skilled at ignoring such debates — good impulse, I say! — his thesis is that the ebb and flow of wealth and status between classes that once characterized American culture has ended. He marshals vast evidence that we now have two separate worlds, one for the lowers and one for the uppers, and a huge chasm separates them. He demonstrates this with vast amounts of data that label the lower third of all races as essentially falling apart in every way. Increasingly, the lowers are characterized by divorce, unemployment, social alienation and economic stagnation, while the uppers are stable in all the opposite ways. The Unsolved Euro Crisis By Dan Amoss Jacobus, Pennsylvania The Euro crisis is not “solved.” Not by a long shot. Yet Bloomberg reports this morning (i,e, March 2nd) that European leaders “declared a turning point in the Greece-fueled debt crisis.” The next project for the busybodies: a commitment to a “pro-growth agenda.” This agenda, we can be sure, will involve the few remaining creditworthy EU governments borrowing even more money for stimulus plans. It’s a New World, and America Is Not Leading It by Jeffrey Tucker Auburn, Alabama In the last decade, something astonishing has happened that has escaped the attention of nearly every American citizen. In the past, and with good reason, we were inclined to imagine that if we were living here, we were living everywhere. We were used to being ahead. The trends of the world would follow us, so there wasn’t really much point in paying that close attention. This national myopia has long been an affliction, but one without much cost. Until very recently. Exclusive Chris Mayer Interview Goes Offline Monday! Here’s Your Personal Invitation to “Join” Me on a Free Worldwide Guided Investment Adventure As We Search For...  — Clues behind the gold legend of El Dorado, along with ways to play a brand new gold boom... — Investment opportunities along revived trade routes stretching from the Middle East to China... — The No. 1 inflation-beating asset of the rich and famous... and more.  No fees, passports or credit cards required. And you won’t have to wait in customs or airport security lines. For details, see your invitation right here. The Weekly Endnote... And now, we turn the floor over to a reader who took the time to incorporate not one but two recent themes we’ve been covering of late in these pages, US housing as a potential investment AND the concept of a “Permanent Portfolio.” (For Fellow Reckoners who’ve already submitted their own “PP,” remember to keep an eye out in future issues, where we’ll feature a selection your ideas and thoughts.) This one comes from Reckoner Alexis L. ... 1. “Buy a House!” (in the US — nice discounts; DR 7 APR 2012 followed by “To Buy or Not to Buy” DR 10 APR 2012). With inflation around the corner, the point is to keep away from cash, especially the USD. So the tangible asset of a home will be just fine. Rent it out. Do leverage with a mortgage, because the real principle amount borrowed will become smaller and smaller (making repayment a breeze) as inflation erodes the borrowed dollar value. Even if the interest rate eventually will rise, rent will keep up with inflation and should cover the mortgage payments. Oh and don’t forget to factor in property taxes on the cost side. OK and if the rules are to list a public security or index, then Vanguard’s REIT “VNQ” should do. 2. Precious metal: silver “SLV” iShares Silver Trust. Why silver and not gold? Perhaps silver has more upside potential than gold (then again, perhaps the silver market really is rigged and we outsiders have no chance at this game?) And although arguments in favor of gold are irrefutable (I’m a DR disciple, after all), the rumors of fake gold bullion in circulation are scary: the gold-plated tungsten bars that masquerade as 400-ounce “Good Delivery” gold bars. Even “GLD” can’t assure that the gold bars backing their ETF really are genuine. Heck, perhaps all gold in Fort Knox is fake! 3. Energy: Vanguard’s ‘VGENX’. This is an essential component of our portfolio, whether we’re bullish (peak oil) or bearish (worldwide economic recession) on energy, our homes need to be heated and our wheels need to keep turning. 4. Agriculture, PowerShares DB Agriculture “DBA” because the world’s growing population needs to be fed; 5.Australian $ bond. Currency bond other than USD, EUR or CHF. I like Australia’s healthy economy, 19% of which is mining-related and feeds Asian demand.  --- As always, we welcome your own thoughts and musings. Feel free to email them to the address below and... ..enjoy your weekend. Cheers, Joel Bowman Managing Editor The Daily Reckoning ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor atjoel@dailyreckoning.com