This article was originally published in the Australian Investors Association quarterly magazine ‘Investors Voice’.
As active fund managers, we continually assess our investment portfolio to determine if we should maintain our positions in investee companies. We give consideration to a broad range of factors and monitor investee companies for signs that may represent a catalyst to sell.
Signs that may contribute to our decision to exit, or at least re-evaluate, our investment in a company include:
- Director selling
We are generally sceptical when a company’s board members substantially sell-down their position. Typically, a company’s directors have more insights into that business than anyone else in the market. Therefore, when directors (particularly executive directors) sell their shares, this can sometimes amount to a vote of no confidence in the company.
Furthermore, when a director reduces their equity in a company (their ‘skin in the game’), the alignment of their interests with the company’s shareholders also reduces.
Therefore, we closely scrutinize Change of Director’s Interest Notices announced to the ASX, which disclose when directors are selling securities in a company. This can be an important signal for us to sell or at least investigate the reason for the sale.
- Share price is at a 12-month low
Another signal to sell a stock can be when its share price hits a rolling 12-month low. When this occurs, it frequently indicates there is a fundamental issue with the company and it has lost the support of the market. In our experience, once a company’s share price falls to its one year low, it will often continue to fall.
Conversely, when a company’s share price hits a 12-month high, this can reflect a degree of momentum in the market that could drive its share price higher.
A scan of the daily share market tables reveals those listed companies that have hit 12-month highs and lows.
- The ‘story’ changes
We look for company managers who take a disciplined and consistent approach to setting and implementing their strategy. We meet with investee companies regularly (at least bi-annually after results announcements) and this gives us the opportunity to ask some of the same questions over a period of time. A lack of consistency in a company’s message raises concerns about the business’s strategic direction and is a key factor impacting our investment decisions.
- Incentive structures change
We spend considerable time and resources understanding what drives a company’s CEO and executives to ensure they are motivated to act in line with shareholders’ interests. Incentives are critical to our understanding of the leadership team’s motivations, which can impact their decision-making. In effect, incentive structures shape a company’s behaviour and when incentive structures are changed, the company’s behavior also changes.
For example, if a CEO is incentivised to aggressively grow the company, this may lead to a debt-fuelled buying spree leaving a hole in the company’s balance sheet.
- The founder sells-out
We consider it a significant positive for a company if its founder maintains equity in the business he or she helped to establish. The founder’s ‘skin in the game’ demonstrates they have faith in the business and ensures their interest in the company’s long-term success. Therefore, when a founder sells, or substantially sells-down, their stake in a company we query the future prospects of that business.
- Large investors exit
A shareholder owning more than 5% of a company must notify the market if they cease being a substantial shareholder.* We closely watch substantial shareholder notices announced on the ASX to identify if large investors are entering or exiting a company. When one of these large investors announces it is no longer a substantial shareholder, it may indicate they are planning to completely exit their holding. As large positions can take many weeks (or even months) to unwind, this may put downward pressure on the company’s share price in the short-term.
While we can only make inferences from substantial shareholder announcements, they can provide valuable insights which may feed into our investment decisions. Investors should note that when large shareholders announce they are no longer a substantial shareholder, they may only be temporarily exiting, or modestly reducing, their holding in the company. For example, fund managers of open-ended investment vehicles may be forced to sell some of their shares in order to fund redemptions.
A final word
We monitor investee companies on an ongoing basis to identify factors that may signify a catalyst to sell or sell-down our position. In some instances, a decision to sell is based on an aggregate of some of the signs discussed above. In other cases, one factor alone is so significant it is a catalyst to sell. Taking an active approach to investing is critical to identifying the sometimes subtle signs that a company may no longer represent a worthwhile investment proposition.
* A shareholder is a substantial shareholder if they own five per cent or more of a company