You will be able to write a thesis for each position and the evidence that would make you sell.
During the FY4 downturn, Larkspur's shares fell to a low of S$1.30, on the made-up path from lesson 10.2, Trend, support and resistance as a description of past trading. A colleague of Marcus's had held them with a stop order 15% below his purchase price of S$1.60, at S$1.36. The stop triggered near the bottom, he sold, and he watched the shares climb to S$1.95 over the next year and a half. Nothing in the business had broken, since its customers had only paused orders in a downturn, as cyclical customers do, and then resumed them.
A price-based exit sells when the price says so. A thesis-based exit sells when the evidence says so. This lesson shows how to write the second kind, with Larkspur as the example. Figures are made up.
A thesis is a short written statement of why you own a holding, what you expect to happen and over what period. It's the memo from lesson 9.8, Build a comps table and write an investment memo, cut down to a paragraph you can reread in a minute.
Marcus's thesis for Larkspur reads: "I own Larkspur because its parts business earns about 19% on its capital, protected by the months it takes customers to qualify a new supplier, and because the price of S$1.60 assumes revenue growth of about 1% a year against about 7.5% over the last cycle. Over three to five years I expect revenue to grow roughly in line with my customers' guidance, at an operating margin near 13.5% through the cycle. I'll judge it on that period, and a single half-year won't settle it."
A thesis has to be specific enough to be wrong. "Larkspur is a good company" can never be disproved, so it can never tell you to sell. "Revenue grows at a 13.5% margin while it keeps its two big customers" can.
Prices move for many reasons that have nothing to do with a company's value: a fund selling to meet redemptions, a sector-wide scare, an index deletion, a market-wide fall. Lesson 4.7, Which headlines fade from prices and which do not, showed how often such falls reverse. A stop order can't tell those reasons apart. It treats a 15% fall from forced selling the same as a 15% fall because the company lost its largest customer.
A thesis can tell them apart. When Larkspur falls, Marcus asks one question: has anything happened that contradicts my thesis? If a customer has cut its spending guidance for a year, that's part of the cycle his thesis already expects. If a customer has announced it's moving half its orders to the second supplier, the thesis has broken, and the price is beside the point.
This works in both directions. A price rise isn't a reason to keep a holding whose thesis has broken, and a fall isn't a reason to sell one whose thesis holds. What a fall does do is make the position smaller and the potential return larger, which is a prompt to reread the thesis before doing anything.
For each holding, write two or three pieces of evidence that would mean the thesis is wrong, each with a threshold you can check in a public document. Marcus took his from the memo:
The top two customers fall below 50% of revenue with no new customer replacing them; operating margin falls below 12% in a year when revenue holds up, pointing to price pressure rather than the cycle; or the board spends its growing cash on an acquisition outside the parts business, as it did with coatings
For his US chip designer, the evidence was different. Lesson 5.6, Short selling, borrow cost and what short interest tells you, and lesson 6.7, Results announcements, earnings calls and the 10-Q, both found inventory growing faster than sales. Marcus's thesis there includes the line: "If inventory days rise for a third straight quarter after the product launch management said they were building for, the demand story is wrong."
Some events don't break a thesis but should make you reread it straight away rather than at your next scheduled review, so they go on the page as well.
Results announcements are the obvious ones: twice a year for most SGX companies and four times for US companies, as lesson 6.7 described. Add a change of chief executive or chief financial officer, a change of auditor, any breach or renegotiation of a debt covenant, and, for Larkspur in particular, the refinancing of its S$40 million term loan in three years. A large insider sale, a new related-party deal or a big jump in short interest belong on the list as prompts to look closer, and none of them is a reason to sell by itself.
A review has a fixed output: thesis intact, thesis weakened with the reason, or thesis broken. Only the last leads to a sale.
If thesis review is this simple, why do so many investors hold losers for years? Behavioural Finance: why you make the money mistakes you make covers the causes in two lessons. Lesson 6.1, Selling winners too soon and holding losers too long, explains the pull to wait until a losing position gets back to what you paid. Lesson 7.3, Sunk costs in policies, renovations and losing investments, explains why the money already lost feels like a reason to stay. A written thesis is the practical defence against both, because the evidence is written down before the loss arrives, when it's easier to be honest.
Marcus's colleague now writes a thesis for each holding instead of setting stops. His first review, after a poor set of results, ended with "thesis weakened: margin down with revenue, one more half-year to see if it's the cycle". It took fifteen minutes and involved no trade.
Get the list of every stock you own and, for each, the reason you bought it, however vague, ready to turn into a written thesis.
Write a one-paragraph thesis for each stock you own with two pieces of evidence that would make you sell.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).