Compound

Thinking of Selling? Focus on Compound Returns

One of my favourite investing aphorisms is the following:

“Don’t just do something, stand there!”

The line has been attributed to any number of people (Eisenhower and Clint Eastwood amongst others), but has since been appropriated by the investing world.  Well, this year so far has been a true test of my ability to resist doing something in my portfolio.

2018…Meh.

Having returned over 42% in 2017 I went into 2018 feeling pretty good.  42% by anyone’s standards is something to be satisfied with.  Unfortunately this year hasn’t produced a similar return, with my portfolio up a meagre 2.8% year-to-date.  So with nearly seven and a half months gone, the holdings in my portfolio haven’t really gone anywhere overall.  Thus, the devil has been a-knocking at my door, enticing me to take some sort of action.

Now, readers of this blog will probably have caught on to the fact that I seldom do much with my holdings.  I don’t trade, in fact I usually only buy or sell a handful of times each year at most.  My strategy is as simple as I can make it.  Buy good quality companies at good-to-reasonable valuations and continue to hold them.

That being said, logging in once a week to check my holdings and seeing little to no change is definitely testing my patience.  I’d be a liar if I suggested otherwise.  Coincide this with a few of my more expensive holdings having returned around 80% or more in a short space of time, discipline is definitely necessary.

My Strategy

Which is why I’ve been thinking long and hard about a strategy to help mitigate this desire to do something.  As fate would have it, a Financial Times article was circulated this week on Twitter on just this subject.  It’s a brilliant read (Take a look for yourself.  When you’re finished here, of course), but my favourite part is a quote from Charlie Munger:

If the valuation gets a little silly, I just ignore it.  So, I own assets that I would never buy at their current prices but I am quite comfortable holding them.”

And that’s the jist of it.  I don’t know about you, but I find it far easier to make a buy decision than a sell decision.  Of course, if there is an announcement materially affecting one of my holdings I will review whether to keep it.  But beyond that I am happy to hold.  Compounding only works if you let it.

Advanced Medical Solutions

Which brings me to my little case study for this week.  Advanced Medical Solutions PLC (LSE:AMS).  I purchased AMS on June 13th 2016 for a purchase price of £1.9345.  The share price as of August 11th 2018 is £3.55, which is an 83.5% return in just over two years.  The mathematically minded amongst you will have calculated this to be a compound annual return of 32.34%.

Compound
Source: Tradingview.com. Click to expand.

Herein lies the dilemma.  I bought AMS at something like 22 or 24 times earnings.  A reasonable valuation for a healthily growing company, and one I was happy to pay.  However today its P/E is 38.  Now we’re looking at a different beast entirely.  Would I pay that today?  Probably not.  I would of course look at it’s current growth rate in both revenues and net income to help me decide.

AMS has grown revenues at 15.47% compounded for the past three years.  It has grown net income at 15.44%.  Impressive enough, for sure.  The company has a proven record of growing at a steady, almost predictable rate for the past decade (in fact, net income has compounded at 23.47% since 2008).  But would I pay 38 times earnings for this growth?  Again, probably not.  So in Munger’s words, the valuation has probably gotten “a little silly”  but I will be continuing to hold for the foreseeable future.

Compound Return

Let’s look at the maths.  In a little over two years my investment has compounded at 32.34%.  Say the valuation is a little ahead of itself and it takes 12 months to have a breather, during which time the share price doesn’t move at all.  My return would still be 21.13% p/a.  Very respectable.  If it didn’t move for two years?  15.69% per annum, compounded.  Would you be happy with an investment that compounds at over 15% for four years?  I’d say so.  There are going to be times where your investments don’t do anything.  If you believe in the business, you must resist the urge to act.

“Don’t just do something, stand there!”

Happy investing!

Find me on Twitter @BritishInvestor, or leave a comment below.

Disclosure, AMS is a constituent of the portfolio.

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