What we mean by Buy, Hold and Sell

We like to make our articles educational and interesting here at Intelligent Investor, to help beginners on the road to investing zen and to give the practising value investing monks something to meditate upon. We also try to raise a smile – occasionally even a laugh – to lighten the load. But ultimately, what you pay us for is to tell you what to do with your shares.

Most of the thousands of words we write are devoted to this, but we appreciate that you don’t have time to read every one of them, and that they don’t always leave a lasting impression. So we provide a synopsis on the stocks we cover in the form of an overall recommendation, a price guide (usually), a maximum recommended portfolio weighting and a couple of risk ratings.

The trouble is that these are relatively blunt tools, and yet they must convey our message to thousands of members, with different objectives, different tolerances for risk and who have acted differently with respect to previous recommendations. A degree of interpretation is therefore necessary, and the purpose of this article is to explain how you might go about it.

We’ll begin by stating the problem. Imagine we’ve just upgraded a healthcare stock to Buy at $1, with a recommended maximum portfolio weighting of 5% and risk ratings of Medium-High. Two weeks later it announces success in a trial for a new form of vaccine and that US pharmaceutical giant Pfizer has taken a 20% stake at $1.50. The stock quickly races to $2, yet given the new information we still think it’s attractive and retain our Buy recommendation. Indeed with doubts about the trial being removed, we nudge our risk ratings down to Medium and our maximum recommended portfolio weighting up to 6%.

How you might react to all this will depend what you did with the original recommendation: if you passed on it, you might still think of buying, especially if you’re more comfortable with the new risk ratings; if you ‘dipped your toe in the water’ with a weighting of 2%, all things being equal it would now be 4% and you’d probably just hold; but if you’d started with 4% you’d now have a weighting of about 8% – well beyond our new recommended maximum of 6% – and you should consider selling a good chunk of your holding. So we have members that should be buying, holding and selling the same stock.

Sells and Avoids

With this in mind, let’s run through our different recommendation categories, starting with the most straightforward: the Sells and Avoids. If we’re saying ‘Sell’ or ‘Avoid’ a stock, then we don’t think you should have it in your portfolio – but we continue to cover it, because of its interest to members (perhaps due to a previous positive recommendation), or its relevance to an overall sector which offers other opportunities.

Generally speaking, if we find it hard to point to a price at which we’d be happy to buy a stock – perhaps because there’s a fundamental problem with its business (think Qantas), or management, or it carries too much debt – then we’ll make it an Avoid and leave off the price guide. Where it’s just a matter of price, then we’ll typically make a stock a Sell and provide a price guide to show when we think our view might change.

Holds

Our Sell price on a stock will typically be pitched at (or more likely slightly before) the point where we think there is no value – which you’ll also hear us describe as no ‘margin of safety’. As we creep below this point – and into our Hold range – then value starts to emerge, slowly at first, but increasing all the way to the point that we’re happy to say Buy. It sounds simple enough, but it’s in the Hold range that most of the confusion arises, because it’s where our advice is most sensitive to your personal circumstances.

There are some quality businesses, for example, which we’ve recommended in the past and which are still worth holding, but which no longer offer enough margin of safety to warrant a Buy. Yet they keep performing well and their value – and share price – keep increasing. So we’ll keep these stocks as Holds, but it will make sense for you to Sell chunks as your holding nears our recommended maximum weighting (or whatever weighting you feel comfortable with). Examples here would include the likes of CSL, Sirtex Medical and Hansen Technologies.

On the other hand, there are stocks that we’re not quite ready to make Buys across the board, but which are more attractive to some members because they meet particular objectives. If you’re very conservative, for example, but nevertheless still want long-term exposure to shares, then you might find it hard to build a portfolio just from our Buy recommendations, as the safest, steadiest stocks often just don’t make it there – so it’ll be worth looking at some of our preferred Holds (typically the ones closer to our Buy price).

If you’re looking for a particular level of income (from shares), then again you might struggle to achieve a sufficient yield just from our Buy recommendations and it’ll be worth looking at our preferred Holds.

We should add a proviso here, that it’s dangerous to ignore value for the sake of chasing yield (or safety), but value is a continuum and Holds that are close to our Buy price might already offer the right attributes to attract some investors with particular objectives, even though we’d recommend that most people wait.

Finally, some people might just want some exposure to a particular sector for reasons of diversification – or you might be starting a portfolio from fresh (or investing a new chunk of money) and don’t want to wait (and hold cash) while the Buy recommendations come along. Here our recommendations and price guides can at least give an indication of our preferences: we think you’d be better off with a Hold that’s close to our Buy price than one that’s close to a Sell (or of course which has already become a Sell or an Avoid).

Buys and Spec Buys

After all that confusion, we can get back to calmer waters with our Buy recommendations. Typically we’ll make a stock a Buy if we think it offers sufficient value (aka margin of safety), that most members, with typically balanced portfolios, should consider buying some. Where we make a stock a Buy, we'll always provide a maximum recommended portfolio weighting, but it will generally be best to start well below this, to allow room for the stock to rise before you need to sell some, and to provide scope for a top-up if the price falls. In some cases we'll be particularly explicit about this, such as where a turnaround is underway but it's hard to know how long it will take. When we upgraded Woolworths recently, for example, we recommended that you build your holding gradually.

Our Buy recommendations also won't suit everyone because of ethics and risk. We have a Buy recommendation on Crown Resorts, for example, but many investors will be uncomfortable with the fact it makes much of its money from people gambling theirs away. We leave it up to you to make decisions on ethics, but we can offer more help with risk via our business and share price risk ratings. The meaning of these is reasonably obvious, but for a fuller explanation take a look at last year’s article: Risk ratings and portfolio weightings.

Where the risks are particularly severe – and especially where they depend on external factors – yet we still see value in a stock, then we’ll label it a Speculative Buy and give it a relatively low recommended maximum portfolio weighting – typically 2% or 3%.

Price guides

To help provide context for all of this, in most cases we’ll put a price guide on a stock, to give an indication of where we’ll consider changing our recommendation. We'll sometimes leave out the price guide, though, where a stock’s value is particularly sensitive to an external factor, or where that value is especially hard to judge, or changing quickly.

An example of the former would be a commodity producer like Santos, whose value depends heavily on the price of the relevant commodity. So the company’s value may move up or down by tens of per cent – along with the share price – without anything happening within the company that’s worth us reporting on (we assume you don’t want us telling you every time the oil price moves by a few per cent). Of course in our reviews we’ll try to explain the sensitivity, and we’ll provide updates where the gap between price and value changes substantially.

An example of where we’ve dispensed with a price guide due to a company’s value being too hard to judge would be Sirtex Medical. At current prices we don’t think there’s enough margin of safety to warrant a Buy but, while everything goes well, its price is likely to keep marching upwards with earnings, which is to say relatively rapidly. Rather than chase it higher with our price guide, and risk it becoming quickly out of date, we prefer to express our thoughts about value in words rather than numbers and remind those holding the stock to take profits on the way up.

Even where we do provide a price guide, it’s important to note that things change with companies and markets – sometimes faster than our price guides can keep up. We do our best to keep them in line with our thinking, but nevertheless the recommendation is paramount, with the price guide merely playing a supporting role.

Under review

Where things have moved so quickly that we no longer have confidence in our recommendation, then we’ll sometimes place a stock Under Review, pending further research. We try to use this recommendation sparingly, however, and will always aim to revert to one or our more usual recommendations within a week.

Portfolios

Our Growth and Equity Income portfolios were originally conceived as a means of demonstrating how you might use our recommendations to manage a portfolio, but they entered real life last July and began accepting money for investment (see here for how to invest). As a result they are no longer a demonstration, but they have perhaps become even more useful as real-life examples (and more useful still if you actually want to follow them by investing).

The difference is subtle, but it means for example that we won’t hesitate to buy or sell our Hold recommendations, if we think it will help meet the portfolios’ objectives (as we did recently by increasing our Equity Income Portfolio’s exposure to banks – see the comments to that article for a discussion of the subtleties involved). We won’t, however, buy our Sell recommendations or sell our Buys, except in limited circumstances to take profits (such as in the example we gave at the beginning).

Further explanations

All of that is how we try to do it but, as we’ve already noted, we’re limited to some fairly blunt tools – and we don’t always swing them with 100% accuracy. Where there are obvious nuances, such as when we think you should manage your weighting to a stock in a certain way (perhaps by increasing your holding gradually as a price falls, or taking profits as a price rises), then we’ll try to explain this in our reviews, so pay special attention to the final few paragraphs where this sort of thing is typically covered.

And of course if you don’t understand our reasoning, then don’t hesitate to ask – either in the comments section of an article or via our Q&A forum.

Note: The Intelligent Investor Growth Portfolio owns shares in Hansen Technologies. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.