This month, I’m considering making the first sale from our portfolio, to cut our losses in Seadrill (SDRL). I think now is a good time to address our approach to selling, which stems from our focus on long-term, income-oriented returns.
Every recommendation I make is bought with the intention of holding for years, even decades. That means I look for investments with timelessness and longevity as well as short-term catalysts. I take this long-term view to maximize our holdings’ income-generating power. Dividends become more powerful, and usually make up a larger part of your annual return, the longer you have held the investment.
For example, if you had bought Wal-Mart (WMT) in April 1990, your current yield on cost would be about 19%. That means you’d be collecting 19% of the value of your original investment every year from dividends alone. If you invested $10,000, you’d now be collecting $1,921 in dividend payments every year.
With investments like these, it’s best to let your money work for you as long as possible.
That can mean riding out some tough times. Wal-Mart declined 23% during the 2000 bear market, for example. Selling would have saved you some money in the short-term, but you also would have forfeited that 19% annual yield.
That’s not to say you should hold obstinately through every crash and bear market. Instead, you should consider what you stand to gain and what you stand to lose by holding or selling. That means taking into account:
• When you bought the holding. If you’re sitting on a decent profit and collecting a nice yield on cost, selling to avoid short-term pain may do you more harm than good in the long term.
• The company’s or asset’s long-term prospects. Is the holding weak because the broad market is weak, or has something changed in the company’s or asset’s long-term outlook that means it may underperform long-term?
• Alternatives. Are you collecting a 6% yield on cost in a low interest rate environment? Are you holding a stock that’s trading sideways while the market is declining? That might be worth holding on to. But if you’re holding a 2%-yielding bond when similar new issues are yielding 4%, or holding a flat-lining stock while the market roars ahead, it may be worth selling and moving your cash to somewhere it can work harder.
Most of these rules will apply in the short-term as well. Since we just launched our portfolio, I’m giving our holdings some time to get going, and will tolerate quite a bit of sideways action. However, I still don’t want to be tied up in underperformers if our money could be working harder. I’ll continually reassess the value of staying in any positions that look like laggards, even if they’re just trading sideways.
Trading downward is another matter, and that’s the reason I’m considering letting Seadrill loose. Losing a chunk of your capital up-front is harder to recover from than you think, and not worth tolerating for the promise of long-term returns. Once your initial investment is depleted, your remaining capital has to work even harder to make up the difference. Ignoring dividends for the moment, consider this:
Let’s say you bought 120 shares of SDRL at 36.00. That’s a $4,320.00 investment. If SDRL then loses 10%, trading down to $32.40, you’ve lost 10% of your capital, and your shares are now worth $3,888.00.
If SDRL now trades up 10%, are you back to breakeven? No. Your remaining $3,888.00 can’t work as hard as your original $4,320.00, so gaining 10% now only gets you back to about $4,276.80. SDRL would now have to go up about 11.11% for you to get back to breakeven.
The math gets even worse the more you lose at the beginning.
In addition, even though our yield on cost on Seadrill is stellar, around 11%, the current yield is higher, at nearly 12%. So we wouldn’t be sacrificing a locked-in yield on cost by selling.
Stay tuned to my updates in the coming weeks for the latest on Seadrill.