I was talking with someone and then sent them the email below. I figured others might find it useful so I made some minor edits and posted it. Some of the stuff might be a little out of context (made sense in terms of our conversation though)
quick note. I am very deliberately using the words stock/price vs business/company below.
I was thinking about our talk the other day especially when you said pvtl is the kind of stock that you would sell if it went up 10-20%. To preface this, by no means am I a buy and hold forever person, business’s change, sometimes for the worse. However, I think you should almost never trade a stock just based on what the price has done, especially a quick 10-20% jump. I bought PVTL because I thought the business had the potential to be to amazing, bigger and more profitable in the future. It is a very young company so I didn’t buy a ton. I thought the stock got ahead of itself after it’s first earnings. I didn’t sell any because the company was doing well, when the stock came back down to earth I bought a little because the business was doing well and the valuation improved. With its next earnings I sold 60% to bring my allocation in line with my conviction. I still think PVTL can be dramatically bigger/more profitable in the future and I’m willing to give them a little time to figure it out…just not with as much of my money as before.
Some general rules.
First and most importantly. You shouldn’t buy any company that you want to sell if you get a quick jump in price. What we are espousing is that you should be buying companies that you think will be dramatically bigger/profitable in the future. In that scenario if you sell when you have a 10-20% jump you will lose out on your gains and only hang on to your losers. Why sell the stuff that is performing well? Don’t let the fear of loss hamper your returns. You should sell a company if you think the business is no longer going to be dramatically bigger/more profitable in the future. Selling because a stock has gone up is almost never a good idea.
Second. When a business is performing well you should buy more. This can be uncomfortable because generally when a business is performing well the stock price is going up and the valuation of it may be going up too.
Third. Avoid the temptation to go bottom fishing on price alone. Generally when the price of a stock is going down the business is performing poorly.
Fourth. Buying and selling should be put in the context of what the business is doing first, valuation second, but almost never what the price of the stock is doing.
Fifth. Allocation limits and diversification are to protect you from yourself. You set the limits when you don’t have strong emotion. Then follow them despite your states of emotion. For example NTNX is my largest position in terms of capital invested. I think the business is performing very well and i’m super excited (notice the emotion). The valuation on NTNX has improved dramatically. I have not bought more at this much improved valuation in case I’m wrong because of my allocation limits. This is one of my favorite posts on the fool, https://discussion.fool.com/conviction-can-be-dangerous-32756562… by Gauchochris. It is worth a read regarding conviction and leverage.
Just a quick example as a friend recently emailed me with 3 stocks I had recommended for him in dec 2014. Lets use those as an example just because I have them. Here is their price and performance. Lets pretend you put 1k in each.
Price-2014 Price - Now Current dollars
CRTO 32.64 23.3 $713
DIS 69.62 114 $1637
NFLX 52.71 367 $6962
your 3k portfolio would be worth 9312 dollars, a 32.73% annualized return. If you had sold NFLX every time it jumped you would have sold it MANY time and lost out on your strongest performer. In fact, one month after you initially would have bought nflx it dropped to 47, then over 2 weeks jumped to 63. Then dropped to 47 over the year. You would have sold, patted your back and lost out on an incredible run up to 367. That similar pattern would have played out greater than 10 times over the next 4 years.
To sum it up, in regards to the business. Buy what is doing well, sell what isn’t. The stock price will eventually catch up.
best,
Ethan