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An Exit Strategy from the Father of Value Investing

By Dr. Steve Sjuggerud
Monday, August 5, 2013

"My favorite holding period is forever," investing legend Warren Buffett likes to say.
Hey, that's my favorite holding period, too... It's great when you can buy the right investment at the right price, and it just keeps on delivering. Buffett has found these businesses better than anyone.
But most stocks aren't something you can hold forever. How do you decide when to sell?
Buffett's hero and mentor, Ben Graham, came up with an interesting strategy for this...
Graham is known as the "father of value investing." He defined our ideas of how and when to buy stocks "cheap." Buffett and other successful investors have taken Graham's ideas and built on them, making billions of dollars.
Graham's ideas about "what stocks to buy" get all the attention. But what most people don't realize is, Graham also had interesting ideas about when to sell...
In their recent (and very good) book, Quantitative Value, Wesley Gray and Tobias Carlisle quote a 1976 interview with Graham...
What's needed is, first a definite rule for purchasing [so] you're acquiring stocks for less than they're worth. Second, you have to operate with a large enough number of stocks to make the approach effective. And finally, you need a very definite guideline for selling.

To meet his three criteria above, Graham suggested:
•   Buy stocks with a price-to-earnings ratio of below 10 and a debt-to-equity ratio below 50.
•   Hold a minimum of 30 stocks.
•   Either sell once you're up 50% or sell in two years, whichever happens first.

In Quantitative Value, the authors showed how well Graham's strategy would have worked from 1976 to present...
The compound annual rate of return would have been 17.8% annually – an incredible return. It blows away the stock market in general, which returned 11% a year.
The authors go in-depth about why the strategy works in the book. In short, owning a basket of cheap stocks allows you to make money as they get more expensive. And by following an exit strategy, you're consistently rolling into the cheapest stocks available.
Graham is the father of value investing. Everyone talks about his ideas for when to buy. Nobody talks about his ideas for when to sell... which were apparently just as good, based on the track record.
A great trade includes a smart buy and a smart sell. Graham clearly thought about both.
What's your exit strategy? Graham says, "You need a very definitive guide for selling."
If you don't have one, you ought to figure that out... and soon!
Good investing,

Further Reading:

"Most people don't know when to sell a falling stock," Steve writes. "So they're frozen into inactivity... until you hear the all-too-familiar phrase, 'Well, it's too late to sell now.'" But by creating an exit strategy, Steve says "you'll never lose another night's sleep worrying about which way your investments will go tomorrow... Because unlike most investors, you'll have a plan." Learn how to create your own exit strategy here.
Steve says when many investors "see a profit, they want to sell." But to outperform the market and make incredible gains, "you must do this one simple thing: You must give your winners a chance to win big." Learn how to lock in 995% profits here.

Market Notes

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Humana (HUM)… insurance
American Financial Group (AFG)… insurance
Johnson & Johnson (JNJ)… Big Pharma
Lockheed Martin (LMT)… "offense" contractor
E*Trade Financial (ETFC)… brokerage firm
Charles Schwab (SCHW)… brokerage firm
MasterCard (MA)… credit cards
News Corp (NWS)… newspapers
Washington Post (WPO)… newspapers
CVS Caremark (CVS)… drugstores
Bed Bath & Beyond (BBBY)… home furnishings
Goodyear Tire (GT)… tires
AutoZone (AZO)… auto parts
Smith & Wesson (SWHC)… guns
Best Buy (BBY)… electronics
Under Armour (UA)… "sporting" products
General Mills (GIS)… Big Food
Tyson Foods (TSN)… meat
Starbucks (SBUX)… coffee
Hershey (HSY)… chocolate
3M (MMM)… manufacturing
ConocoPhillips (COP)… Big Oil
Chesapeake Energy (CHK)… natural gas producer
Chart Industries (GTLS)… natural gas storage
iShares U.S. Consumer Fund (IYC)... the American consumer lives on
iShares Transportation Average Fund (IYT)... transportation stocks
iShares Technology Fund (IGV)... Big Tech stocks
iShares Dow Jones U.S. Industrial Fund (IYJ)... industrial stocks
iShares Nasdaq Biotechnology Fund (IBB)... biotech stocks
ProShares Ultra Health Care Fund (RXL)... drug stocks

CurrencyShares Australian Trust (FXA)… Australian dollar
Hatteras Financial (HTS)… virtual bank
Expedia (EXPE)… online travel
Agrium (AGU)… fertilizer
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U.S. 20+ Year Treasury Bond Fund (TLT)... Treasury bonds

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