28. When to sell stock like Warren BuffettJun 06, 2021
welcome to course 3 unit 1 lesson 1
stocks for many people
stocks is kind of a mystery game for them it's almost like they are rolling the dice if they should continue to sell buy more buy something else hopefully This lesson for the start from Course 3 will help you easily determine if you should sell stocks, buy stocks, or whatever, so let's get started and I'll walk you through the methodology. One of the things that Buffett does really well is that he knows
whenand if he should always sell shares every time he buys his shares he always has the opinion that he plans to own them forever, so his intention is never to buy something low and then sell it when is high your intention is to buy it low and continue to hold it through the life of the business but in some situations you need to sell the stock and usually it always revolves around two rules so the first rule you have is that you will sell the stock if you can expect a higher return from trading in another asset and when you take into account when you make those transfers that you have to account for capital gains and one more thing I would like to add is that you not only account for the capital gains that he's going to pay and then he's going to lose when he transfers assets, but he's also factored in the level of risk as he moves from one asset to another, so he'll want to find something that has similar risk if he's looking for a comparable return after paying capital gains. taxes, so it may seem a little complicated and that's what this whole lesson is about: figuring out that change and whether it's worth the trade and then the second variable you use to determine whether you should sell something is whether the company has changed its fundamentals back in course 2 unit 3 we discussed his four rules for buying common stock and all those different principles those tenants if any of those tenants change after he's bought ed the shares that's the only reason for him to go ahead and sell stocks so let's say you bought a company to manage your debt well and you kept the debt to equity ratio below 0.5 and added a current ratio above 1.5 and things like that let's say two or Three years in, the company no longer owns those fundamentals, well that's a very good reason for you to sell those shares, regardless of the trading price, because the fashion for that company has changed its shape. that it's working and that's something you might want to run away from depending on which direction the change is going so let's go ahead and focus on that first tenant where we'll basically figure out how to assess that change in value from one asset to another after you account for capital gains tax ok i'll give you a scenario this is just a generic scenario it really has nothing to do with current market trends of how low it was in 2009 or anything like that don't read too much just look at the raw numbers because that's what I'm trying to get at here so I'm going to lay out a scenario for you where there is a stock of a company and the ticker for that company is xxx ok the The market price of company xxx is $50 per share and the book value of that company is $48 per share, which is very close to the market price and you have been through all these different techniques that we learned about in unit 3 from course 2 to evaluate expected book value growth and all that stuff you can calculate intrinsic value so I'm just showing you the key terms you need to know to calculate that so expected book value growth of this company it's based on past performance and future earnings and all of that will be 7% per annum now.
I know I've told you in the past that if you always want to buy a dividend-paying company, but to make the calculation a little easier, just say If we're not going to be dealing with any companies that are paying dividends, we're just going to assume that all the profits that the company earns will be returned to the company's equity, which will be shown as book value. okay and that's grown to 7% and this company's debt to equity ratio is right where we want it a five point or less so it's right on target there and our future earnings will be consistent with what we've seen in the last 10 years so based on the numbers when we compare xxx to let's say the ten year federal note right now is 3% though that's not what it is we'll just say for this generic scenario In the year 2009, which was three years ago, let's say interest rates were 3%, so how would we calculate the intrinsic value of that company at that time?
Let's find out before we move on to the next scenario, so I'm going to pull out the Buffett one. books intrinsic value calculator to do that quick calculation ok I have Buffett's ebooks.com website open and to go to the intrinsic value calculator the first thing we're going to do is go here and mouse over the calculators tab we're going to go down to intrinsic values that stocks ok and it takes us directly to our intrinsic value calculator which is all you have to do is scroll down and based on the information I gave you you won't really have to put anything in the top calculator because I already gave you what the expected book value growth is going to be, so we can go down here to the bottom calculator and we can see that all the numbers we need are already there, okay? cash that will be taken out of the business we said the dividend is zero so we'll put it in there okay that's our expected dividend over the next ten years the current book value is $48 so we're going to go ahead and put that in the average percentage change in book value per year, so this is the number seven percent that we have here, the seven percent annual growth is how much we think that $48 book value is going to grow each year over the next few years. next ten years, so we're going to put seven in there, which means seven percent and then we'll discount it again it's going to be the 10-year federal note, so it's going to last ten years and we'll use a three percent federal bond. take that into account and we're going to calculate the intrinsic value, okay, and as you can see, we have seventy dollars and 25 cents, so we're going to round this up to say that the intrinsic value of this company is now seventy dollars per share.
If any of what I just described doesn't make any sense to you, you'll probably want to go back to unit three, lesson five, to really understand how the intrinsic value calculator works, so after all those numbers through our intrinsic value calculator we know company xxx which is trading in the market at $50 a share we think its value is worth $70 a share when compared to a 10 year 3 percent federal note ok so when we look at that let's say we would go ahead and buy some shares of this company because it was a decent price it was trading at 50 and we think it's worth 70 by comparing it to the note so let's say we bought a thousand shares of company xxx and we bought those shares at $50 each so therefore this is a $50,000 investment that we just made in this company okay that's the company that we own and what I'm going to do now is walk you through through a sale scenario let's listen up let's go ahead and go ahead and go time up to three years later so let's see how our investment went and do we want to continue to hold it or maybe buy something else ok we've owned company xxx for Three years, all right, and time has progressed in an unusual way for our company. he hasn't really performed as we expected based on all those numbers we really thought X X X was a strong pick but at the end he's showing some really strange signs so let's go ahead and go over those so the first thing we're naturally going to look at is the market price.
Three years ago every time we bought xxx company the market price was $50 but now we got really lucky and the company is trading in the market at $70 a share so it was very lucky I mean it was where we predicted the price. be but let's see if it's really worth $70 a share just because it's trading there doesn't mean it's necessarily worth it so when we go down and look at the book value of the company which is three years later we see that the the book value is the same amount as the previous three years, which is a bit strange, especially since this company hasn't paid dividends, so it's a bad sign that the book value hasn't really grown, one You would think that the market price would have trended with the book value, but it didn't, as we look at the expected book value growth right now, it's now at five percent, which is considerably lower than what we thought three years ago the dividend is still zero and as we look at the debt to equity number we can see that it's much higher than where it was at 3.0 and that number is not good that number is pretty scary and, to be honest with you, we could go to that second tenant where this company has changed its fundamentals with how it manages its dead and actually we would probably ignore the company and sell the companies specifically just for that reason okay now the last thing we're seeing is probably the The most important factor of the mall and that is that the forecast of future profits is getting lower and lower, okay in the previous scenario, when we bought this company three years before, those profits were consistent and constant with the previous 10 years. and the forecasts for the future were looking at the kind of earnings, but now the earnings are actually going down, so between that and the debt to equity ratio being a little bit higher, that would be the only reason to sell this company, but to show you the math. behind it because it may not be as apparent with some of their picks so I'll show you the math behind it so we can determine if we should sell the company and trade it for something else via a ten year federal node. or whatever the case might be, so when we look at the value of the company today, which is three years from now, it's going to be a completely different value than what we were three years before and that's what we're going to find out what the intrinsic value value calculator again so let's go ahead and fill in let's find out what the intrinsic value of the company is today and when we look at the ten year federal note let's assume the ten year federal note is now four point five percent if you're a member before it was three percent but now it's four and a half percent so it's going to give a different intrinsic value to this company especially since our market price is different on all those different variables okay let's go back to our intrinsic value calculator and find out how much this is worth with all the new variables ok so here we are again at the intrinsic value calculator take the same path as What we took earlier to get here when we look at the cash that can be taken out of the business is still going to be 0 because it's not paying a dividend now when we look at the current book value it's still the same because the book value the company didn't add money to the value Accountant now you might be wondering why the market price has gone up $70 and you know how many times some of these things don't even make any sense, like why did the company go up in value when the book didn't grow and they haven't paid a div I can explain that and a lot of the funds you won't be able to explain but that's not the point sometimes these markets move in directions you can't even consciously understand but what you can do is value so that's what what we're doing here okay so the book value is still 48 now the average percentage change in the book now right now we're evaluating the book value will only grow 5% where before we were saying when growth is 7% so that's a big difference and we have to put that change in so we're going to change that to five okay which is symbolic of 5% we're still going to have the top of the calculator in the next ten years because then let's compare it to the ten-year federal note now before the ten-year federal note was at 3% but now it's four and a half percent, so that's going to change the value of our company , so we put 4.5 percent and just remember the holding federal Note is nothing more than a ruler that's a yardstick for r a zero risk investment that you can put your money into and that's why you're comparing it to that 10-year federal note, okay, let's go ahead and click calculate and you can see that the intrinsic value of this company has changed dramatically from where we were three years earlier, so now the intrinsic value of this company is $50 per share and in e The market can see that the market price is $70 per share, so the intrinsic value is much lower than the company actually is. trade for good that's not a good thing that means if we continue to hold it we're going to lose money okay so to answer our question herepaying all this money in federal and state taxes before doing the math on how much it's going to grow, that's fine, but to keep things simple, we'll just assume we pay federal taxes and that's it. and that the rest of the money that remains ns, we will see what will happen if we put that money in the TTT company, okay, the first thing we have to do and this is step three, what will be returned in our new selection, like this that we have to solve it.
How much are we going to make once we take our $66,000 and buy the TTT company? So to do that, let's go back to the intrinsic value calculator from Buffett's books, okay, and what we're going to do is take the cash out of the business, no dividend is being paid out, okay, so it's going to be zero. the book value by chance is still 48 bucks will almost always be different from your previous pick so it's just a pure coincidence when we look at the book average percentage change this is a little different the TTT of this company is a little higher at 6% ok the number of years will still be 10 and our 10 year federal note if you remember is still 4.5% currently so we'll go ahead and hit calculate if you remember that's the case as we calculated it came out earlier it's $55 the current market price is $50 so we have a change like we did before for company xxx we have to change this 10 year federal note until the intrinsic value equals our sea price $50 so to make this number go down we have to make this number on our federal holding note larger okay so let's go ahead and make it 5% and see what happens okay we we're zooming in, it changed the intrinsic value to $52, we want it. to be 50 we're not going to stop until it equals 50 so let's go ahead and try 50.5% ok when we put 5.5% here we have the intrinsic value to match the current market price of $50, so we know that if we're going to buy a company t-t-t-that we're going to get 5.5 percent that's what we estimate we're going to get a 5.5 percent return at the current market price okay, so we answered that question for our step three and now we know if we buy the TTT company at the current market price we're going to make 5.5 percent a year for the next 10 years that's what we asked them okay so the last The next step we have is to figure out how much that $66,000 investment will be if it grows at 5.5 percent per year, so we go back to our basic formula and so you know how many shares we could buy, you'll take your $66,000 divided by your fifty dollars a share and you can buy buy 1320 shares of the new company and those shares would grow so our present value is sixty six thousand dollars it will grow 5.5 percent so when we plug those numbers into the formula our future value will equal to one hundred twelve seven hundred thirty seven dollars and that would be the value in ten years from now which year would be twenty twenty two so let's go ahead and recap what happened here it's okay if we decide that if we continue to keep the company xxx based on all the new trends in the data that our future market value in ten years would be worth seventy-seven thousand dollars and then we figured out after paying for the capital gains we got from company xxx and then traded it in company t-t-t -that the future market value would grow to one hundred and twelve thousand dollars in that same time period, so the smart move here for the smart investor and the person who understands the security analysis is that your decision to transfer the money and sell your shares of company xxx and trade it in company T TT is a thirty five thousand dollar decision so this concludes course three unit one lesson one when you sell shares I hope that the information has been informative and I hope to see you in the next lesson
If you have any copyright issue, please Contact