When to sell stocks (it's not easy)

What an episode we have for you this week, packed with stock analysis and hard-earned wisdom.

This episode, Greg Canavan and I assess the winners and losers of the reporting season so far. 

We profile Coles, Woolies, Altium, WiseTech, Carsales, Data#3, and HUB24.

Even Domino’s gets a mention, the tech stock disguised as a pizza merchant, or is it a pizza merchant disguised as a tech stock?

Anyway…

We then turn to one of the most important questions of them all: when to sell stocks.

Using his recent sell decisions as examples, Greg takes us through the sell process.

In investing, as in life, it’s OK to be wrong, not to stay wrong.

Scrambling for earnings growth or earnings certainty?

The reporting season ramped up last week, with plenty of heavyweights confessing their FY23 results.

But the ASX 200 has been largely flat. The big moves have come from individual stocks, especially on the day of earnings release.

Retail stocks had some of the worst moves.

Adairs closed 15% lower last Monday. Kogan closed 11% lower last Tuesday. And Lovisa closed 6% lower last Thursday.

To me, that suggests we haven’t hit peak pessimism in the retail sector yet.

The worst wasn’t priced in. If it was, these stocks wouldn’t fall so sharply on results.

But tech stocks enjoyed a strong run.

Last Wednesday, Altium closed 25% higher, Megaport closed 17% higher, HUB24 closed 11% higher, while Nuix and Audinate finished about 10% higher.

The Aussie Information Tech index is up more than 30% year-to-date, while the ASX 200 is up only 3%.

Since its June 2022 low, the tech index is up 45%.

Does this imply capital is scrambling into anything showing earnings growth and dumping anything showing weakness, irrespective of value?

Not necessarily.

Not all tech stocks are surging (more on WiseTech later). And not all retailers are plummeting.

It’s all a little more nuanced than that.

It comes back to earnings hits or misses. 

Investors are paying for certainty and discounting uncertainty.

Take Altium, Carsales, and HUB24.

Greg ran the numbers on these stocks during the episode and the valuations suggest these solid stocks are trading at a ‘certainty premium’.

The question, however, is how much that premium is worth.

Can you overpay for certainty?

And what happens when that certainty proves illusory?

High disappointment is baked into high expectations.

How much are Coles, Woolies, and Domino’s worth?

This episode featured plenty of stock analysis…and stock valuation.

To get the full rundown, check out the episode. But here are some quick estimates of intrinsic value for Australia’s duopolistic supermarket giants, Coles and Woolies.

Let’s start with Coles first.

Using FY24 consensus estimates and assuming a discount rate of 8% and a dividend payout ratio of ~80%, we get a valuation of $14.7 a share. Or about 8% overvalued.

What about its rival, Woolies?

Woolworths reinvests more into the business, with a payout ratio of about 70%.

Again, using a discount rate of 8%, we get an intrinsic value estimate of $33.4 a share, about 10% overvalued.

Is that the certainty premium at work?

Finally, let’s turn to Domino’s.

Domino’s is a funny stock. A pizza franchise touting its technological capabilities, the stock surged during the pandemic only to fall ~70% from its September 2021 all-time high.

The rollercoaster continued last week.

DMP closed 11% higher on the day of its FY23 results, despite net profit falling 74% to $40.6 million.

Based on that figure, the pizza merchant is trading on a trailing P/E ratio of 100. Quite the multiple for a franchise doling out pepperoni pizzas and curbing growth of new stores.

The optimism likely stemmed from management’s positive outlook.

Domino’s said it expects FY24 to deliver ‘material sales and earnings improvements’, mainly stemming from ‘structural savings’.

It also gave a positive trading update for the first seven weeks of FY24. Network sales grew 12.6% during the stretch and same store sales rose 2.8%.

Is the market thinking the worst is behind Domino’s?

Potentially, but let’s run the numbers.

Using FY24 consensus forecasts, a discount rate of 8%, and a payout ratio of 80%, we get a valuation of $33 a share.

That’s suggests Domino’s is a whopping 35% overvalued.

Hmm…

Is the market applying a more favourable discount rate?

Applying a discount rate of 6% gets us to $51 a share. But that’s a skinny rate, implying almost no risk given where the Aussie risk-free rate is currently.

Sticking with 8% as the required rate, we get to the current market price if we assume FY24 ROE is a tad over 35%.

Domino’s FY23 ROE was 26.5%.

How much future turnaround growth and profitability is the market pricing in already?

When to sell stocks

And now to the second theme of the podcast — knowing when to kill your darlings (or duds).

You will never get every investment decision right.

Error is inevitable.

Being wrong is inherent to the game. Learning to do it well makes you a better player.

Scott Fearon, a fund manager with a great track record, said the best investors are great ‘quitters’.

As soon as fundamentals shift, they bail:

‘I’m not perfect at what I do, by any stretch, but I am a very good quitter. I’d say I’m one of the better quitters I know. And that skill has helped me a lot over the years.

‘Like I’ve said, the best money managers are also the best quitters. They quit early and they quit often. As soon as they see things turning for the worse, they don’t wait around, they bail.’

Winning investors don’t anchor decisions on what was paid, but the current worth.

The price you paid for a stock is irrelevant to its current and future prospects.

As Aussie investor Colin Nicholson wrote in Building Wealth in the Stock Market (emphasis added):

‘What has already been spent cannot be changed. That money is gone. No matter how much the stock cost us to buy, it is irrelevant to what we do now. In evaluating a losing investment, the only focus of good investors is how much the investment is now worth and what action will be likely to yield the best return from here onwards.’

Selling decisions stem from a wider management of one’s portfolio.

You shouldn’t necessarily buy a stock and forget about it for years.

Periodically, you must reassess the story and the business. Is the initial thesis still matching with reality?

If the stock has run-up in price, ask yourself if further upside remains and whether any potential remaining rewards warrant the risks.

If the stock is falling, sequester your ego and appraise the initial investment case impartially.

Did fresh information reveal flaws in your original thesis?

Is your thesis no longer applicable due to unforeseen changes?

Were your assumptions too strong?

In investing, error is predestined. The severity of error is not.

It’s OK to be wrong, not to stay wrong.

Enjoy the episode!