Don’t uproot the flowers and water the weeds

By Howard Coleman

One of the most frequently asked questions at Teaminvest is: “When should we sell?”.

Members have the opportunity to achieve 15-20% returns p.a. when measured over an economic cycle. We define this as being over 5-10 years.

In order to achieve these desired returns, we should "water the flowers and uproot the weeds". Most investors however, are encouraged by their brokers and the media to do the opposite.

The consequences of these two opposing strategies are visible in portfolio composition over time.

How Two Identical Portfolios Diverge

Albert and Barbara pursue opposite selling strategies based on using Conscious Investor® software and the outcomes of monthly Teaminvest SMaRT workshops. Both aim to achieve 15-20% annual returns when measured over 5-10 years.

Both have $2m to invest in companies they expect to generate good, safe returns over time. They work together to choose 20 companies that pass the Conscious Investor® filters and that had a positive outcome in at least one SMaRT. They realise that most of these should do well in 5-10 years while a few may disappoint. They each invest exactly $100,000 into each of these 20 companies at the same prices on the same day. They thus start with identical portfolios and both re-invest all dividends.

Whether or not they achieve identical returns will now depend on their investment philosophy and most particularly why they sell.

Albert's Portfolio Over Time

Albert believes you can never lose by taking a large profit. He will sell and take a profit whenever any company in his portfolio goes up in value by more than 50% in under two years, or doubles in less than 5 years. He will recycle this money to add to his holdings in those companies that are now cheaper than when he first bought them.

As time goes by, the best run companies increase their Earnings Per Share (EPS) the most. Their share prices rise above one of the targets Albert set and he joyously takes these juicy profits, recycling the money to those of his 20 companies that are now the cheapest relative to when he first bought them.

Albert feels wonderful every time he takes a juicy profit. Over time, he concludes he's a very good investor - taking fat profits and recycling money into companies at prices most often less than he paid earlier. His instinctive brain will tell him to repeat this strategy whenever he can.

When we look at Albert's portfolio after several years we won't see any recent Wealth Winners®. Every company that has increased its share price by 50% in less than two years, or doubled in less than 5 years, will have been sold. When Albert now lists his 'Top 10 Holdings by Value' no company in this 'Top 10 List' will look like a recent Wealth Winner®.

Barbara's Portfolio Over Time

Barbara takes a different view. She decides to keep any company that continues to increase EPS - no matter how much the price rises. She decides instead to immediately sell any company where EPS drops in any two successive years no matter the price. She expects share prices will fall if EPS falls so she steels herself to take some losses. She will recycle the money into those companies that increased their EPS the most, provided she can add to them at P/E multiples no higher than her first purchase.

Despite passing Conscious Investor® and at least one SMaRT, a few companies disappoint and their EPS drops in two successive years. Barbara sells them as planned. She recycles the money into those of her original 20 companies that are still increasing EPS and which are at P/E multiples no higher than she paid previously.

Barbara will find this strategy tough to adhere to. She will hurt every time she sells at a loss. Her instinctive brain will tell her to change tactics and she'll struggle to stick to the strategy.

When looking at Barbara's portfolio after several years we will see several recent Wealth Winners®. Every company that has increased its EPS and share price will still be there. These companies will almost certainly have risen in value to become her biggest holdings.

The Divergence of the Portfolios after Several Years

Albert and Barbara start with identical portfolios: exactly the same companies at exactly the same prices and with exactly the same $100,000 invested in each. Now several years later they will each have sold a few companies – Albert those where he could take a large profit, Barbara those where she experienced a double drop in EPS.

Barbara will now have in her 'Top Holdings by Value' several recent high-performing Wealth Winners®. Albert will have as his 'Top 10 Holdings by Value' only mediocrity.

Albert will say "it's so hard finding Wealth Winners® in the market today". Barbara will say "I'm slowly and surely building a Wealth Winning portfolio through Teaminvest."

Albert would have found his strategy psychologically easy to follow. Barbara would have found her strategy mentally tough to follow.

If they compare portfolios after many years, Albert will be amazed at the 'luck' Barbara has been blessed with.

Is this a great story or can we learn something?

The investment community is mainly comprised of people like Albert. Reference dependency tells them to take profits and they sell all their big winners. Over time their portfolio fills with mediocrity. In our language, they never own any Wealth Winners®. Or as Benjamin Graham and Warren Buffett have said "They uproot the flowers and water the weeds."

Successful investors take the mentally tougher route – using EPS as their determinant of what to hold and when to sell. They retain their Wealth Winners®, and sell the poorly managed. Over time their portfolios look more like Barbara's, containing an ever increasing number of Wealth Winners®, which like cream, 'rise to the top' to become their largest holdings.

Are you a self-directed investor who is interested in finding Wealth Winners® for your own share portfolio or SMSF?

Teaminvest is a private membership organisation whose members meet monthly for educational MasterClasses, Triages and SMaRT workshops. They also enjoy access to Conscious Investor®, a powerful stock picking cloud-based application that contains proprietary tools developed over decades by Teaminvest co-founder Dr John Price. To find out if Teaminvest is right for you, and if you would be a good fit for Teaminvest, book a call with long-time member Chris here.

Conscious Investor® is a registered trade mark in the US and Australia. Other trade marks used on this site and in Conscious Investor include Wealth Winner®. All trade marks are used under license.

This article contains general investment advice only (under AFSL 334339). Authorised by Mark Moreland.