Selling When Things are Divorced from Reality

One of the most challenging aspects of investing is determining when to exit a position. Unfortunately, it seems the very best share in this opinion, as evidenced by a recent Charlie Munger interview. When asked if he could provide his system for selling securities, Mr. Munger replied “I don’t think I’ve got a system yet, and so I’m just learning as I go along.” An incredibly humble answer from a gentleman who is now 97 years old!

This, of course, was not the first time this question had been asked of Mr. Munger. At the 2002 Berkshire Hathaway Annual Shareholders Meeting, the duo was asked “How do you decide when to hold forever and when to sell?” Warren Buffett responded that although it is not their natural inclination to sell, there are at least two scenarios where they would. First, if they needed the money for something else (i.e. they found a better idea), or, second, if they were re-evaluating the economic characteristics of the business (the competitive advantage has changed or eroded).

Perhaps in between these two scenarios is another that constitutes part of a sell discipline – when the market price of a stock has, for whatever reason, been completely and utterly divorced from reality. A recent example of this was the recent Support.com stock short squeeze (read all about it here).

We started a position in Support.com last year, as the company checked many boxes for us including: high insider ownership, a clean balance sheet with positive net cash (i.e. no debt), a recurring service revenue business model, and strong free cash flow generation. The stock was, in our opinion, incredibly cheap at $2 a share versus our estimated intrinsic value of around $6.

Then, the entire fundamentals of the business changed in March of this year when it was announced that the company would merge with Greenidge Generation Holdings Inc – a natural gas power plant with an massive attached bitcoin mining operation. The stock immediately tripled on the news, and we began to trim the position with the plan of eventually exiting upon the one-year mark (to avoid short-term capital gains taxes). After all, we are not particularly interested in owning a bitcoin mining operation. Nevertheless, volatility in the stock price persisted over the next five months, and we continued to trim when this volatility was working in our favor.

Recently this volatility reached new heights as the stock went from $8.81 on August 20th to $36.39 on August 30th due to an extreme example of a short squeeze. Again, this is a price fluctuation that is completely divorced from the reality of the underlying business fundamentals. On the way up, of course, there were many opportunities for investors with a cost basis in the low single digits to exit their positions, which I am sure many did. I am also certain that essentially all of them did not cash out at the 52-week high of $59.69 (there may have been one lucky one)!

While we did not have many shares left (as we had been trimming the entire ride up) we decided to exit the position before the one-year mark. Mr. Market was giving us an opportunity we couldn’t refuse. At a selling price of $40, our final position provided us a 20x return. 

But the problem with a stock price that has become completely divorced from reality is that you never know where it’s going to go. So, while we made the intellectually correct decision to trim on the ride up and finally take the money and run at $40, we had to endure some emotional anguish seeing the stock go up to this level. We wish we sold our whole position at $40 – a terrible case of the “shoulda, coulda, wouldas!”

Peter Lynch has a saying, “you can’t lose money in a stock you don’t own” and while seemingly such a simple idea, many investors do torture themselves with money they feel they missed out on. Basing part of our sell discipline on when share prices advance beyond all reasoning can ease our pain, as we can rest on the fact that we made the decision rationally in a sometimes incredibly irrational market.

Oh, and making 10x never hurt anyone either.