Warren Buffett’s annual shareholder letter came out last month. As usual, it was widely covered by the mainstream media and numerous financial analysts. There is not much I can add to what was already written about it in the press. Though there is this one minor angle on investing that has largely escaped attention. I want to focus on that in this post.
In this year’s letter, Mr. Buffett talked about increasing the intrinsic value of Berkshire Hathaway by either buying large businesses outright (his first preference) or by investing in publicly traded companies (his fallback choice). For this second option, he went on to say that “today, though, we find little that excites us.”
The Question: This itself is not news to any Buffett follower. He’s been saying that for some time. But it also brings a different but related question to my mind. If he believes that publicly traded stocks have high valuations today, why is it that he hasn’t sold any of his major holdings. For instance, his Apple (AAPL) stake as of Q4 2021 of 887 mn shares (about 48% of his total stock portfolio) is unchanged from Q4 2020 [source: 13f.info]. The same goes with the next three major holdings of his: Bank of America (BAC), American Express (AXP), Coca Cola (KO). He didn’t sell any of these stock positions (or even a fraction) to take advantage of current high valuations offered by the stock market. In 2021, Apple stock rose 37% (not counting dividends). Bank of America gained 48%, American Express 39%, and Coke by 12%. These were substantial returns for a single year.
He didn’t add to these four positions, but he didn’t sell any shares either. Why?
Apple is a business that I also own. So, I am always interested in what other well-regarded fellow investors have to say about its share price.
To further shed light on Mr. Buffett’s reluctance to sell his winners, here is what Charlie Munger (vice chairman of Berkshire) said during this year’s Daily Journal Corp’s (DJCO) annual meeting:
Question: “You recently talked about bubbles and high valuations. Is Costco a part of that? Costco has never traded at a higher price-to-sales or price-to-earnings multiple.”
Munger’s Response: “I’ve always believed that nothing was worth an infinite price. Even an admirable place like Costco could get to a price where you would say that’s too high… I can’t bring myself with my habits to pay these big prices. But I never even think about selling a share of Costco just because it’s selling at a high price.”
Costco is another stock that I’ve owned for many years. It’s certainly been trading at historically high valuations since 2021. For the whole year 2021, Costco shares have risen by about 49%, excluding dividends. And yet, just like Buffett, Munger would not sell any of his shares even at today’s high valuations either. What gives?
Howard Marks is another investor that I respect for his views. In his recent memo (published January 2022), he also touched upon the same topic. He argued that it does not make sense to sell things just because they are up. Investors are inclined to view unrealized gains as only temporary. They could go away. Hence, they sell to make these gains “concrete”. His counter argument is that if an investor sells just to realize capital gain, he will inevitably reinvest the sales proceeds and therefore again take risks.
It’s worth reading this entire section from the memo:
“If you sell an appreciated asset, that puts the gain “in the books,” and it can never be reversed. Thus, some people consider selling winners extremely desirable – they love realized gains. In fact, at a meeting of a non-profit’s investment committee, a member suggested that they should be leery of increasing endowment spending in response to gains because those gains were unrealized. I was quick to point out that it’s usually a mistake to view realized gains as less transient than unrealized ones (assuming there’s no reason to doubt the veracity of the unrealized carrying values). Yes, the former have been made concrete. However, sales proceeds are generally reinvested, meaning the profits – and the principal – are put back at risk. One might argue that appreciated securities are more vulnerable to declines than new investments in assets currently deemed to be attractively priced, but that’s far from a certainty.”
Don’t bail: The key lesson I take from the words and actions (rather, inactions) of these three master investors is that selling a good business (even when it is highly prized by fellow investors) is not a good idea unless I need to raise cash for some other purpose. Like raising cash to spend or to increase dry powder. Having large unrealized gain does not by itself justify bailing on a stock. Liquidating a position to invest in a new stock is also fraught with risk. The longer I’d owned a stock, the better I understand its business. I can’t say the same for a new stock that I had just finished evaluating.
Turning to my own stock portfolio, I have several large positions with significant unrealized gains. Am I inclined to sell to realize those gains? No. As I wrote in a January blog post, when I need to raise some cash, I sell a fraction of my stock holdings but otherwise I don’t sell just because they are up a lot over the years. I don’t bail on good businesses. It also keeps my capital gain taxes in check.
For more of my thoughts on selling a stock, see this post from January 2020: Buy Right, Sell Never.