In most cases, it is because the company seems to be undervalued by the market, because they expect that company to be a much bigger one in years to come or because they just believe in the business model.
Either way, it is the one part of investing that is well covered. The area that is not so well documented is when an investor should sell.
Fund managers have many more tools and a lot more knowledge at their disposal than the majority of private investors. They will set price targets or automatically sell down their exposure if – due to a period of good share price performance – it begins to dominate their portfolio.
However, it isn’t as clear-cut for private investors. They are repeatedly told that they should take a long-term approach to investing in equities – a view that is tried and tested. However, if a stock has done particularly well over a short period, would you have the bottle to carry on holding it?
Take a company like ASOS. It has returned a staggering 86,169.67 per cent over 10 years. Although there are probably a few investors who have not changed their holding over that time, there are likely to be many more who decided that a 1,000 per cent return was good enough after 18 months and who trimmed their position. But is this always the right move?
Performance of stock over 10yrs
Source: FE Analytics
David Jane, manager of the £33m TM Darwin Multi Asset fund, agrees that not enough attention is given to the selling side of investing and says it is all about maintaining a degree of discipline.
"It’s a very good question that I don’t think gets asked enough," he said. "However, to answer it from my experiences, I’m going to take a bit of a step back."
"Fund managers face many challenges and the probability of getting it right every time is low. If you can get it right 55 per cent of the time, I think you are doing very well."
Jane, former head of equities at M&G, admits that there is no sure-fire tactic to either build or preserve your wealth by investing in equities, so he tries to follow three simple steps.
1. Avoid an emotional response
"Firstly, you need to be unemotional about the decisions you make. You have to try not to get too excited when things go up nor too depressed when they go down. It is extremely difficult to do, but you have to remain rational," he said.
2. Think about why you own the stock
"The second is to focus on a decision and not the outcome. Ask yourself why you bought it and whether those reasons remain valid. The outcome can be completely dominated by randomness, and if they go up and down it doesn’t mean you are a good or bad stockpicker."
3. Don’t be afraid to admit you were wrong
"The third may sound obvious, but in this case it is the most important. If you are right, run your winners, but if you are wrong, cut your losers early," Jane said.
Jane explains there have been times when the majority of his portfolio has done well, but a number of smaller holdings were not pulling their weight, yet he held on to them anyway.
"I think as a fund manager, I am quite good at cutting the big high-profile losers – which some aren’t so good at."
"However, I really struggle with the ones that are quietly failing in the background. It can be easy to do because the market is going up and you don’t think a little underperformance is much of a problem."
"You have to be quite disciplined because, though you may not be able to see them, they are losing you capital and so you would be better off selling them and using it somewhere else that can make you money."
Jane highlights two examples when he should have cut his losses sooner. The first was the US-listed tobacco company Reynolds and the other was FTSE 100 stock Amec.
"There have been a quite a few examples in the past where I held on to a stock for too long, one of which was last year. We held Reynolds, which although it didn’t have one really bad period, it just kept underperforming."
"Another one was the oil support services company Amec. It is a good company, but last year it just kept quietly underperforming," Jane added.
Jane says he held Amec since he launched his TM Darwin Multi Asset fund through to February 2013, during which time the stock lost 2.1 per cent.
Performance of stock from June 2011 to Feb 2013
Source: FE Analytics
The manager has since removed the stock from his portfolio because, as he says, it simply wasn’t pulling its weight.
Jane says that his sell-discipline for individual stocks could also be applied to funds.
"To be honest, I see little difference between stocks and funds in that respect: they both have the same degree of randomness and predictability," he said.
"All the same disciplines apply as they both carry the same investment insecurities. I know fund-of-funds managers who sell down units if they see the mandate change. You just have to make sure you are still investing in a fund for the right reasons."
