Buying too high and/or failing to sell as earnings deteriorate
Selling exceptional companies because they seemed too pricey
At times I have sold shares in companies that I knew were extremely excellent businesses that were very likely to continue to grow their profits per share over time. The reason for selling was that the shares looked very expensive with price to earnings ratios that seemed very high, for example, over 30. Examples of this include Visa, Costco, and Berkshire Hathaway. I have gone on to regret those sales. Each of those three have had occasional declines but for the most part they continue to rise over time. Warren Buffett has long suggested that once you have identified and bought shares in an exceptional business the wisest course is usually to avoid selling. Instead, accumulate more on dips.
Regression to the Mean in P/E ratios
Stocks with significantly above average earnings per share growth rates can justify and do deserve to trade at higher than average P/E ratios. But buying stocks with high P/E ratios does mean that we are effectively paying up in advance for the expected future growth. I’ve considered it to be prudent to assume that a stock with a high P/E such as 30 will tend to regress down towards the market average of say 18 over a five or certainly a ten year assumed holding period. But recent experience has been that many of the higher P/E stocks have remained much higher than average. This certainly applies to Visa and MasterCard.
Conversely, there are some apparently good companies that tend to trade at lower thahan average P/E ratios. At times an assumption that their P/E ratios will rise providing an attractive gain has paid off. But in some cases the laggards to contine to lag.
Winners win and losers lose?
The momentum strategy of investing tends to assume that stocks that are going up will continue to do so. And those going down will continue to do so. When stocks continue to rise because earnings continue to rise, this can certainly be a winning strategy. For the past several years momentum or growth strategies have out-performed strategies based on fundamental value. But that is certainly not always the case.