When looking to invest in a company, Burgundy’s Investment Team performs rigorous analysis. Through extensive scrutiny of a company’s financials, study of the operations, research trips and meetings with company management, we determine whether or not the company fits our criteria for a quality investment. If it does, and at a market price that is significantly less than our estimate of its true worth, we initiate a position.
This discipline results in a high level of conviction in our ideas. We purchase a company because we want to own it for the long term. If all goes well and the company’s intrinsic value continues to grow, we will hold the company indefinitely. Though, as you might guess, the ideal scenario does not always play out over time. So, under what circumstances is it time to sell?
1. Full Valuation
In this first scenario, from the time of original purchase the share price appreciates in value to a point where we believe it is fully valued. This is the ideal sell scenario where an investment thesis works out as planned: we purchase a company at a discount to its intrinsic value, hold it in our portfolio until the market recognizes the company’s true worth (leading to an increase in the share price to the point at which it is no longer undervalued) and we sell at a profit.
Ideally we would only sell holdings in a situation like this. However, often the rationale for selling is more complicated. This is one of many reasons why investing is likened to an art, not just a science.
2. New Opportunities
Our Investment Team may decide to sell shares in a company we own if we find another opportunity that we feel is of equal quality to the existing holding but is trading at a greater discount to intrinsic value. In this situation, selling our existing holding in favour of the new one would leave the quality of our portfolio unchanged while improving the portfolio’s margin of safety.
Another reason for a sale of this nature is because we have discovered a more promising opportunity that we feel is of higher quality, trading at a similar discount to intrinsic value. A sale for this reason would leave the portfolio’s margin of safety unchanged but would improve its overall quality.
Generally, sells of this nature improve the overall quality/value tradeoff of the portfolio and are viewed favourably (see Richard Rooney’s blog post “The Quality-value Tug of War” for more on this tradeoff).
3. Investment Thesis No Longer Holds True
The final reason Burgundy will sell holdings is if the investment thesis is “broken.” In order to make an investment decision, we develop a thesis that outlines, among other details, how we expect the company to perform in the future. We continually monitor our existing holdings to ensure that our thesis is unfolding as expected or in a way that is beneficial to the future prospects of that company.
In some cases, unfavourable changes to a company’s fundamental business occur, leading to a change in our view of the company’s future prospects. If this happens, our thesis is considered to be compromised and the company is no longer an attractive investment based on our criteria. For example, if a company we owned decided to increase its debt to fund an acquisition that we felt was not in the long-term interests of shareholders, we would re-evaluate the business, and potentially void our original thesis.
In a perfect world, everything would unfold as expected and we would never have to sell a holding due to a broken thesis. However, the reality of investing is that no one has a crystal ball; changes happen and mistakes are made. The important element is to recognize when they occur and take appropriate action.
Follow a Disciplined Investment Philosophy
The decision to sell a security is never an easy one and is not one to take lightly. By adhering to a disciplined quality-value investment philosophy for both buy and sell decisions, we ensure that all trades are made to improve the quality and/or valuation of our portfolios. This approach has historically been key to preserving capital by protecting the downside, while allowing for the possibility of above-average returns over the long term.