28. When to sell stock like Warren Buffett Video Lecture | Become an Expert: Value Investing - Business Basics

welcome to course 3 unit 1 lesson 1 when
to sell stock for a lot of people
selling stock is kind of a mystery game
for them it's almost like they're
rolling the dice whether they should
continue to hold sell buy more buy
something else and hopefully this lesson
for the start of course 3 will help you
easily determine whether you should sell
shares buy shares or whatever so let's
get started and I'll take you through
the methodology one of the things that
Buffett does really well is he knows
when and if he should ever sells shares
of stock whenever he buys his stock he
always has the opinion that he plans on
owning it forever so his intent is never
to buy something low and then sell it
when it's high his intent is to buy it
low and to continue holding it
throughout the life of the business but
in some situations he does need to sell
the shares and it typically always
revolves around two rules so the first
rule that he has is he'll sell the
shares if he can expect a higher return
by trading into another asset and when
he takes into account when he conducts
that transfers that he has to account
for the capital gains and something else
that I'd like to add is not only does he
account for the capital gains he's gonna
pay and then he's going to lose when he
transfers asset but he's also taken into
account the level of risk as he moves
from one asset to the other so he's
going to want to find something that's
of similar risk if he's going for a
comparable return after paying the
capital gains tax so that might sound a
little complicated and that's what this
entire lesson really focuses on is
determining that change and whether it's
it's worth the the trade and then the
second variable that he uses when
determining whether he should sell
something is if the company has changed
its fundamentals back there in course 2
unit 3 we discussed his four rules for
buying common shares and all those
different principles those tenants if
any of those tenants change after he has
purchased the shares that alone is
reason for him to go ahead and sell the
shares so let's say that you bought a
company that
to manage their debt well and they kept
the debt-to-equity below 0.5 and add a
current ratio above like a 1.5 and
things like that let's say two or three
years down the road the company doesn't
possess those fundamentals anymore well
that's a very good reason for you to
sell those shares regardless of what the
trading price is because that company's
hip has changed its the way that its
operating and that's something that you
might want to run away from depending on
which direction that the change is going
so let's let's go ahead and focus on
that first tenant where we're going to
basically figure out how to assess that
change in value from one asset to the
other after we account for capital gains
tax okay so I'm going to give you a
scenario this is just a generic scenario
it doesn't really have anything to do
with the current market trends of how
low was in 2009 or anything like that so
don't read into that too much just kind
of look at the pure numbers because
that's what I'm trying to get at here so
I'm going to I'm going to lay out a
scenario for you where there's one share
of a company and the ticker for that
company is xxx okay
the market price of company xxx is $50 a
share and the book value for that
company is $48 a share which is really
close to the market price and you have
gone through all those different
techniques that we learned back in
course 2 unit 3 to assess the expected
book value growth and all that stuff
that you can calculate the intrinsic
value so I'm just I'm showing you those
key terms that you need to know in order
to figure that out so the expected book
value growth on this company based off
of past performance and future earnings
and all that is going to be 7% annually
now I know I've told you in the past if
you always want to buy a company with
dividends but in order to make the
calculation a little easy I just kind of
said that we're not going to deal with
any companies that are paying dividends
we're just going to assume that all the
earnings that the company makes is going
to be put back into the equity of the
business which will be displayed as Book
value okay and that's grown at 7% and
this company's debt to equity ratio is
right where we want it a point five or
lower so it's it's right on target there
and our future earnings are going to be
consistent to what we've seen in the
last 10 years so based on
figures when we compare xxx to let's say
that the ten-year federal note right now
is 3% even though that's not what it is
we're just going to say that for this
generic scenario in year 2009 which was
three years ago let's just say that the
interest rates were 3% so how would we
calculate the intrinsic value on that
company right then and there let's let's
figure that out before we move on to the
next scenario so I'm going to pull up
the Buffett's books intrinsic value
calculator in order to do that quick
calculation okay so I have the Buffett's
ebooks.com website pulled up and in
order to go to the intrinsic value
calculator the first thing we're going
to do is we're going to go over here and
hover our mouse on the calculators tab
we're going to come down to intrinsic
values than stocks okay
and it takes us directly to our
intrinsic value calculator which is all
you have to do is scroll down and based
off the information that I gave you
you're not going to really have to input
anything on the top calculator because I
already gave you what the expected book
value growth is going to be so we can
come down here to the lower calculator
and we can see that all the numbers that
we need are are already there okay so
the cash that's going to be taken out of
the business we said that the dividend
is zero so we'll put that 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 percent change in
book value per year so this is the
number seven percent that we have right
here the seven percent annual growth is
how much we think that that $48 Book
value is going to grow by each year for
the next ten years so we're going to put
seven in there which means seven percent
and then what we're going to discount it
back off of is going to be the 10-year
federal note so it's going to go for ten
years and we're going to use a three
percent federal note and we're going to
calculate the intrinsic value okay and
as you can see we got seventy dollars
and 25 cents so we're just going to
round this off to let's just say the
intrinsic value of this company is
seventy dollars a share
now if any of what I've just described
doesn't make any sense to you you're
probably going to want to go back to the
course to unit three lesson five in
order to really understand how that
intrinsic value calculator works so
after
all those numbers through our intrinsic
value calculator we know the company xxx
which is trading on the market for $50 a
share we believe its value to be worth
$70 a share when we compare it to a 3
percent federal 10-year federal note ok
so when we look at that let's assume
that we would go ahead and buy some
shares of this company because it was at
a decent price it was trading for 50 and
we think it's worth 70 when comparing it
to the note so let's just say we buy a
thousand shares of company xxx
and we purchased those shares of $50 a
share so therefore this is a $50,000
investment that we just made in this
company okay so that's the company that
we own and what I'm going to do is now
I'm going to walk you through a sell
scenario let's listen let's go ahead and
warp in time to three years later and so
let's see how our investment did and
whether we want to continue to hold it
or maybe buy something else
okay so we've owned company xxx for
three years okay and time is progressed
in an unusual way in our company really
hasn't performed like we had expected it
to based on all those numbers we really
thought X X X was a strong pick but in
the end it's kind of showing some really
weird signs so let's go ahead and walk
through those so the first thing that
we're going to naturally look at is the
market price went back three years ago
whenever we bought company xxx the
market price was $50 but now we were
very fortunate and the company is
actually trading on the market for $70 a
share so that was very fortunate I mean
that was kind of where we predicted the
price to be but um let's see if it's
actually worth $70 a share just because
it's trading there doesn't mean that
it's necessarily worth that so when we
go down and we look at the book value of
the company which is three years later
we see that the book value is the same
amount that it was three years previous
which is kind of strange especially
because this company hasn't paid any
dividends so that's kind of a bad sign
that the book value really hasn't grown
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 where we thought
it was three years ago on the dividend
is still zero and as we looked at the
debt to equity number we can see that
it's it's much much higher than where it
was it's at a 3.0 and that number is not
good that number is pretty scary and to
be quite honest with you we could go to
that second tenant where this company
has changed its fundamentals with the
way it manages its dead and we would
actually probably maybe disregard the
company and sell the companies
specifically for that reason alone okay
now the last thing that we're looking at
is probably the most important factor of
the mall and that is that the forecast
for future earnings are consistently
getting lower okay in the previous
scenario when we bought this company
three years earlier those earnings were
consistent and constant with the
previous 10 years and the forecasts for
the future was seeing type of earnings
but now the earnings are actually
decreasing and so between that and the
debt-to-equity being a little higher
that would be reason alone to sell this
company but in order to show you the
math behind this because it might not be
as blatant with some of your picks so
I'm going to show you the math behind
this so that we can figure out whether
we should sell the company trade it into
something else by a ten-year federal
node or whatever the case might be okay
so when we look at the value of the
company today which is three years later
it's going to have a completely
different value than we had three years
earlier and that's what we're going to
figure out what the intrinsic value
calculator again so let's go ahead and
complete let's let's figure out what the
intrinsic value of the company is today
and when we look at the ten-year Federal
note let's just assume that the ten-year
federal note is now four point five
percent if you remember before it was
three percent but now it's four and a
half percent so that's going to put a
different intrinsic value on this
company especially because our market
price is different in all those
different variables okay so let's go
back to our intrinsic value calculator
and let's figure out what this thing's
worth with all the new variables okay so
here we are back at the intrinsic value
calculator again you take the same path
that we took before to get here when we
look at the cash that can be taken out
of the business it's still going to be 0
because the
he'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 any money to the
book value now you might be wondering
why the market price has increased the
$70 and you know what a lot of the time
some of this stuff just won't even make
any sense at all like why the why did
the company increase in value when the
book didn't grow and they haven't paid a
dividend I can explain that and a lot of
the funds you won't be able to explain
it but that's besides the point
sometimes these markets move in
directions you can't even make
conscience sense of it but what you can
do is you can value it so that's what
we're doing here okay so the book value
is still 48 now the average percent
change in book now right now we're
assessing that the book value is only
going to grow 5% where before we were
saying when the growth 7% so that's a
major difference and we've got 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
calculator summit over the next ten
years because then we're going to
compare it to the ten-year federal note
now before the ten-year federal note was
at 3% but now it's a 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 that tenure
federal Note is nothing more than a than
a ruler that's a measuring stick for 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 so we're going to go ahead and
click calculate and you can see that the
intrinsic value of this company has
drastically changed from where we were
at three years earlier so now the
intrinsic value on this company is $50 a
share and on the market you can see that
the market price is $70 a share so the
intrinsic value is much lower than what
the company is actually trading for okay
that's not a good thing that means that
if we continue to hold it we're going to
be losing money okay so to answer our
question down here to calculate the
intrinsic value of one share it's we
think it's now worth $50 a share when we
compare it to the 10-year federal note
at four-and-a-half percent not only did
we find the intrinsic value to only be
worth $50 a share but we also have that
to equity issue and we also see that the
future earnings are consistently getting
lower so these are all signs that you
would potentially want to sell this
stock okay so when you want to sell a
stock you have to have something that
you want to put it into you have to be
able to put it into something else so
our natural inclination is that we could
immediately put it into a ten-year
Federal note and probably get a better
return than where it's at right now
which we haven't done the numbers on
that but if we did I would pretty much
assume that the 10-year federal note
would give us a better return if we
transferred it out of this company now
let's go ahead around and look around
the market and see what other types of
companies we have that we could
potentially trade this for and get into
okay so here's a quick recap
in 2009 we're gonna assume that that's
when we purchase company xxx okay we
bought at a market price of $50 we we
thought that the intrinsic value was $70
so we bought a thousand shares okay
three years later we still own the same
company and the market price came up to
$70 a share but then the intrinsic value
went down to 50 and we still own those
thousand shares so right now we're in a
position where we're looking to maybe
transfer that that money those funds
into something else that's more
lucrative okay as we look around the
market we find that companies are
trading for pretty much a high premium
across the board you're most likely in a
bull market at that point so if you're
looking around the market and you're
having trouble finding anything that's
giving you a good intrinsic value versus
the market price you're probably in a
bull market despite those conditions
because we stumble across the company
called
TTT okay and I'm going to show you the
the numbers on TTT okay so one share of
company TTT we're going to say that the
market price on TTT is $50 a share we're
going to say just by coincidence that
the book value for this company is also
$48 a share just like the last company
okay and our expected book value growth
is six percent with company TTT which is
one percent higher than what we had with
company xxx this company also doesn't
pay a dividend but the debt to equity is
at a point five which is much better
than company xx
right now and the forecast for future
earnings is the same as the last ten
years so that's the good sign company
TTT has a good debt management their
future earnings are all looking good and
the book value growth that we've
estimated is a little bit higher than
the company we're currently holding okay
so when we compare company TTT to a four
point five ten-year federal note what's
its intrinsic value so we're going to go
back to the intrinsic value calculator
okay so we're going to go ahead and put
these numbers in so there's no dividend
payment the book value on company TTT is
also forty eight dollars just by
coincidence it could become something
completely different and you'd still be
able to figure all this out okay and our
percent change in book we're saying is
going to be six percent okay which is
one percent higher than the last company
okay then the years we're going to own
it is ten and ten year federal notice
still four point five percent so let's
go ahead and figure out what company
TTTS intrinsic value is okay it's fifty
five dollars okay and it's trading for
fifty dollars so that's a good thing
we're able to buy the company for lower
than what we think the intrinsic value
is okay so our intrinsic value and
company TTT is fifty five dollars okay
so here's the point of this entire
exercise okay when when you look at all
those variables it might be difficult to
understand what in the world do you do
do you continue to hold the company that
you bought three years ago because
you've made substantial gains and you
might not want to pay capital gains tax
to get out of it and transfer it into
something else or do you just sell it
and do you transfer the money into TTT
or do you buy the ten year federal note
and so there's a lot of variables here
and for a lot of people that might get
confusing and so what I'm going to do is
I'm going to walk you through a step by
step method so that you can determine
what you should do in a situation like
this okay because you're going to be
faced with the situation the more you
trade stock so the question is do you
continue to hold company xxx or you sell
your shares pay the capital gains and
purchase company TTT okay so that's our
question that we're going to solve here
okay
so here's another
recaps of the year on top of everything
that's happened up to this point so
company xxx or market price is $70
currently the intrinsic value we
calculated it to be $50 which is
significantly lower than what it's
trading for that's not good
we own a thousand shares so we've made a
twenty thousand dollar profit by owning
this company for that duration of three
years okay so that's what we're going to
pay capital gains tax on if we decide to
get out of that asset so company TTT the
market price is $50 a share in the
intrinsic value that we just calculated
is $55 a share which is good because
that's $5 we're able to buy that for $5
lower than what it's actually worth okay
and that's how you need to look at that
and we don't own any of these shares yet
we need to determine whether that's a
good buy or not okay so how we're going
to solve this problem is a three step
process first step one how much of a
return do we expect to make with our
current stock okay so if we continue to
hold xxx for the next ten years what is
that money going to turn into that's our
first question we have to answer the
second question we have to answer is how
much do I have to invest in the
alternate stock after I pay the capital
gains tax okay because once we know that
then we know how many shares we can buy
and then we can ask the mate how much
it's going to be so step two is we have
to figure out how much money we'll have
after we pay the capital gains tax
step three is how much of a return we
get from the new pick okay so after we
figure out that capital gains problem we
then have to take that money and pretend
we we buy company TTT and then we have
to estimate how much that will grow to
over the next ten years then what we're
going to do is we're just going to
compare number one and number three to
see which one's a more lucrative pick so
let's start off with step one okay the
return on our current pick okay so we
figured out what the intrinsic value is
but what kind of return are we going to
get if we continue to hold those shares
considering the market price says it's
trading for $70 but we feel it's
worth 50 so if we continue to hold those
shares how much of a return are we going
to get over the next 10 years so let's
go ahead and solve that problem okay so
in order to solve it we have to go back
to our intrinsic value calculator okay
so here we are with the intrinsic value
calculator and what we're going to do is
we're just going to fill out these
numbers and the first one the dividend
is zero because we don't have a dividend
the book value is still $48 the percent
change we only think that the book value
is going to grow by 5% a year the number
of years is 10 and then the 10-year
federal note is 4.5 so when we hit
calculate it comes up with our intrinsic
value of $50 okay which we already we
already figured that out okay so in
order to figure out how much we think we
would get over the next 10 years all we
have to do is we have to adjust this
number instead of having 4.5% in for a
10 year federal note we're going to
adjust that number until our intrinsic
value equals the current market price
okay so our current market price is $70
okay so I have to adjust this number
here until the intrinsic value equals
$70 or pretty close to it okay so let's
go ahead and just try three percent okay
let's go we want to go down because the
market price is higher than the
intrinsic value okay so we're going to
go ahead and hit calculate and we see
it's at $58 remember we want this to
equal 70 we don't stop until it equals
70 so let's try two percent it Kelly
clean out $64 okay so we're getting
closer so let's hit one and when we use
one percent as our 10-year federal note
okay it shows that our intrinsic value
is 70 dollars okay which matches the
current market price so when these two
numbers match when we have the intrinsic
value equals the market price we know
that we're going to get the same return
is what our input is for the 10-year
federal note and since we put 1 percent
in there that's how much we're going to
make if we continue to hold company xxx
over the next 10 years so annually or
you're going to make 1 percent if you
continue to hold this company so that's
some pretty bad return
that's something that you're definitely
going to want to try to move out of if
you have an asset like that so to answer
our question on the bottom we're going
to make a 1 percent return annually over
the next 10 years ok so how much would
that 1% turn into with our with our
current investment so we know we have a
thousand shares of company xxx ok and
when we take a thousand shares times the
$70 a share we know that that's us that
it's worth $70,000 right now so what
will be the value of those shares in ten
years so in order to do that a little
problem we're just going to use our
future value of money formula okay which
FV is the future value and that's equal
to our present value times one plus I
which is our interest rate raised to the
number of years okay so in this scenario
our present value of $70,000 our i or
our interest rate is going to grow
that's going to grow one percent
annually okay and we're going to do it
over the next ten years okay so we're
going to look at what the value of these
shares would be in the year 2022 okay so
when we do that math problem make sure
you do your exponent first we come up
with seventy seven thousand three
hundred and twenty three dot fifty five
cents so that's what that investments
going to grow into if we just continue
to hold company XXX okay so let's go on
the step two in order to go to step two
we have to be able to pull up with the
with the capital gains tax rate you're
going to be in so for this company
company xxx we made a 20 thousand dollar
gain on this company in a three-year
time frame okay now as you look at the
chart there I have the chart up for 2013
even though it's technically 2012 I'm
using the numbers for 2013 because I
feel that that might be a little bit
better as this video becomes a little
bit old over the next coming years
it'll the chart will be valid okay and
if you're reading my book my book uses
the numbers from previous to 2012 so
you're going to see the numbers differ a
little bit from the book to this video
so as we look at those numbers this
would be considered a long-term capital
gain so as you look at the chart you
have short-term capital gains which is
less than a year
long-term capital gains is more than a
year and then you have the five-year
capital gains rate which is a little bit
better you could get into the 8% in 18%
and remember this is only for 2013 and
beyond so for our scenario we fall into
that 10 to 20 percent long-term capital
gains range depending on what your
ordinary income tax bracket is so let's
go ahead and assume that you're in a tax
bracket that's higher than 15% so the
capital gains that you'll pay is 20%
okay so in order to figure out how much
federal capital gains tax you pay you
just take your 20% times your game of
20,000 and that comes out to be a 4%
federal capital gains tax okay so once
we make that payment we know we only
have 66 thousand dollars left from the
original 70 thousand in order to invest
that money somewhere else okay since
we're changing assets we pay the capital
gains of four thousand and then
whatever's left is what we can invest in
the next asset and so since we're trying
to invest in company TTT we know we're
only going to have sixty six thousand
dollars to invest in that company so
this is something that's really
important that you have to account for
because a lot of people might say oh
well you're you're getting an extra
percent more by transferring it into
another company but yeah you have to pay
the capital gains and so once you do
that math it might not make sense for
you to change into the other asset now
this is something that's really
important I want you to remember this
I'm only doing the calculation for the
federal capital gains tax when you're
doing this for really you're also going
to have to account for more money that
you might have to pay to the state so
these are all considerations that you
really got to make as you're as you're
looking at transferring asset from one
asset to the next that you're paying all
this money in federal and state taxes
before you do the math on how much it's
going to grow okay but just to keep
things simple we're just going to assume
that we paid federal taxes and that's it
and that the rest of the money that
remains we're going to see what will
happen if we put that money in the
company TTT okay so the first thing we
have to do and this is step three what
is going to be
returned on our new pick so we have to
figure that out how much are we going to
make once we take our 66 thousand
dollars and we buy company TTT so in
order to do that we come back to the
Buffett's books intrinsic value
calculator okay and what we're going to
do is the cash taken out of the business
no dividend is being paid okay so that's
going to be zero the book value just by
chance is still 48 dollars almost always
that'll be different from your previous
pick so that's just a pure coincidence
when we look at the average percent
change of book this is a little
different this company TTT is a little
bit higher at 6% okay the number of
years is still going to be 10 and our 10
year federal note if you remember is
still 4.5% currently so we're going to
go ahead and hit calculate if you
remember this is how we figured it out
earlier it's 55 dollars the current
market price is $50 okay so we've got a
change just like we did before for
company xxx we've got to change this 10
year federal note until the intrinsic
value equals our market price of $50 so
in order to make this number go lower we
have to make this number of our tenure
federal note larger okay so let's go
ahead and make it 5% and see what
happens okay we're getting close it
changed the intrinsic value to $52 we
want it to be 50 we're not going to stop
until that equals 50 so let's go ahead
and try 50.5% okay when we put 5.5
percent in here we've got the intrinsic
value to equal 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 a 5.5 percent that's what we
estimate that we're going to make a 5.5
percent return at that current market
price okay so we answered that question
for our step three and we now know that
if we buy company TTT at the current
market price we're going to make 5.5
percent annually over the next 10 years
that's what we asked them me okay so the
final step we just got to figure out how
much will that investment of sixty six
thousand dollars
into if it grows at 5.5 percent a year
so we go back to our basic formula and
just so you know how many shares we'd be
able to buy you're going to take your
sixty six thousand dollars divided by
your fifty dollars per share and you'd
be able to buy 1320 shares of the new
company and those shares would grow so
our present value is sixty-six thousand
dollars it's going to grow up 5.5
percent so when we plug those numbers
into the formula our future value equals
one hundred and twelve seven hundred and
thirty seven dollars and that would be
the value in ten years from now which
the year would be twenty twenty two so
let's go ahead and recap what happened
here okay if we decided that if we
continue to hold company xxx based on
both 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 went and calculated
after we pay the capital gains that we
earned off of company xxx and then we
traded it in the company t-t-t-that the
future market value would grow to one
hundred twelve thousand dollars in that
same time period so the smart decision
here for the intelligent investor and
the person who understands security
analysis is going is that their decision
to transfer the money and to sell their
shares of company xxx
and trade them in the company T TT is a
thirty five thousand dollar decision so
this concludes course three unit one
lesson one when the sells stock I hope
the information has been informative and
I look forward to seeing you guys in the
next lesson