Peak Shaving

• The Bottom Line: Peak shaving is the disciplined value investing strategy of trimming a portion of a winning stock after its price has soared far beyond its intrinsic value, allowing you to reduce risk and reallocate capital to more undervalued opportunities.
• Key Takeaways:
• What it is: A risk-management technique where you sell a part, not all, of a highly appreciated and now overvalued position.
• Why it matters: It systematically protects your capital by locking in gains when your margin_of_safety has evaporated and turned into a “margin of risk.”
• How to use it: By setting valuation-based trimming points before you buy a stock, you replace emotional, greed-driven decisions with a rational, pre-planned process.

Imagine you're the manager of a city's power grid. For 360 days of the year, the city hums along with predictable energy needs. But for five days in the blistering heat of summer, everyone cranks up their air conditioning at the exact same time. This creates a massive, short-lived “peak” in demand. You have two choices. You could spend a billion dollars building a massive new power plant that will sit idle 98% of the time, just to handle that peak. This is incredibly inefficient and risky. Or, you could implement a “peak shaving” strategy: offer incentives for people to use less power during those peak hours, or draw from stored energy reserves. You don't shut the city down; you just intelligently manage the extreme, unsustainable demand to protect the entire system. In investing, peak shaving is the exact same concept. Your portfolio is your power grid. Your stocks are the power plants. Sometimes, one of your stocks—perhaps a wonderful company you bought at a fair price—gets “discovered” by the market. The story goes viral, analysts fall in love, and euphoric buyers pile in, sending the stock price into the stratosphere. This is your portfolio's “peak demand.” The stock's price is no longer connected to its fundamental earning power, but is instead being driven by pure emotion and momentum. The amateur investor, seeing the price soar, gets greedy. They might even buy more, right at the top. The value investor, however, recognizes this peak for what it is: an unsustainable, high-risk situation. Their margin_of_safety has vanished. Instead of risking a portfolio-wide “blackout” when the bubble pops, they wisely “shave the peak.” They don't sell their entire position in this great company. Instead, they sell a calculated portion—perhaps 20% or 30% of their shares—at these inflated prices. This action achieves three critical goals:

• It locks in some of the incredible gains.
• It dramatically reduces the risk to their portfolio if (and when) the price corrects.
• It generates cash (stored energy) that can be redeployed into other, unloved parts of the market where demand is low and prices are cheap.

It's a strategy rooted in prudence, not prediction. You aren't trying to call the absolute top. You are simply recognizing that the price has detached from reality and are acting rationally to protect your capital.

“The investor’s chief problem—and even his worst enemy—is likely to be himself. In the end, how your investments behave is much less important than how you behave.” - Benjamin Graham

At first glance, peak shaving might sound like “market timing,” a practice that value investors famously disdain. But this is a critical misunderstanding. The difference lies in the motive for selling. Market Timing vs. Value-Based Trimming

For a value investor, peak shaving is a powerful tool for several reasons:

• It Enforces Sell Discipline: Buying is easy; selling is hard. Greed often prevents us from taking profits on a winner, while fear prevents us from cutting a loser. Peak shaving provides a pre-determined, rational framework for selling, forcing you to act when a stock's valuation becomes indefensible, thereby protecting you from the emotional pull of a euphoric market, personified by mr_market.
• It Replenishes Your Margin of Safety: The core of value investing is buying a great business for less than it's worth. That discount is your margin_of_safety. When a stock you bought for $50 soars to $200, while its intrinsic value has only grown to $80, your margin of safety has not just disappeared—it has become a dangerous “margin of risk.” The price is now propped up by hope, not reality. Shaving the peak is the act of cashing in on that euphoria and restoring a conservative posture to your portfolio.
• It Fuels the Engine of Compounding: The cash generated from trimming an overvalued holding is not for a holiday. It is “dry powder,” the fuel for your portfolio's long-term compounding engine. This capital is now free to be reallocated to a new opportunity—another wonderful business that the market has overlooked and is currently selling at a significant discount to its intrinsic value. It is the ultimate act of “selling high to buy low.”

Applying peak shaving effectively requires a plan, not an impulse. It must be integrated into your investment process before emotion has a chance to take over.

1. Step 1: Estimate Intrinsic Value at the Time of Purchase. Before you buy a single share, you must do the work to determine a conservative estimate of the company's intrinsic_value. This is your anchor of reality. Let's say you analyze “Steady Brew Coffee Co.” and determine it's worth about $80 per share. You manage to buy it for $50, giving you a healthy margin of safety.
2. Step 2: Define Your “Peak Shaving” Trigger Point. This is the crucial pre-commitment. Decide at what level of overvaluation you will begin to trim. This is not a specific price target, but a valuation multiple. For example, you might decide: “If the stock price ever reaches 200% (or 2x) of my current estimate of intrinsic value, I will sell 25% of my position.” In our example, 200% of the $80 value is $160 per share. This is your trigger.
3. Step 3: When Triggered, Re-evaluate Intrinsic Value. A year later, the market goes crazy for coffee and Steady Brew hits $165. Your alarm goes off. Do not sell blindly. First, re-do your work. Has the business fundamentally improved so much that its intrinsic value is now, say, $110? If so, your new trigger point is $220 (2x the new value). You do nothing. However, if your analysis shows the value has only drifted up to $85, while the price is $165, the stock is clearly in euphoric territory. The trigger is valid.
4. Step 4: Execute the Trim and Reallocate. You follow your plan and sell 25% of your shares. You now have a smaller, risk-reduced position in Steady Brew (which you can happily hold as long as it remains a great company) and a fresh pile of cash. Your next job is to find the next company trading at a price far below its intrinsic value.

The goal of peak shaving is not to feel remorse if the stock continues to climb after you sell. The goal is to have followed a rational process that consistently reduces risk and improves long-term returns.

• A “Successful” Shave: You trim your position at $165. The stock continues to $190 before eventually crashing back to $100. You protected significant capital from the fall and have cash to reinvest at the bottom. This is the ideal outcome.
• The “Cost” of Prudence: You trim your position at $165. The stock, defying all logic, becomes a market darling and continues to $500. Did you fail? No. You made a rational decision based on a sound valuation framework. You can't control Mr. Market's mania. You can only control your own process and risk exposure. You still own 75% of your original position and have realized substantial gains on the portion you sold. A value investor would rather miss the last 50% of a bubble's upside than risk the first 50% of the downside.

Let's imagine you are analyzing “American Tower Corp.” (AMT), a cell tower REIT, in early 2017.

1. Step 1: Initial Analysis & Purchase. You analyze its business model (long-term leases, high barriers to entry, growing data demand) and estimate its intrinsic_value to be around $130 per share. The market is undervaluing it, and it trades for $110 per share. You buy a position, happy with your 20% margin of safety.
2. Step 2: Set The Plan. You decide on a peak shaving rule: “If AMT's price exceeds 150% of my updated intrinsic value estimate, I will sell one-third of my position.” Your initial trigger price would be $130 * 1.5 = $195 per share.
3. Step 3: The Market Gets Euphoric (2.5 years later). By late 2019, the 5G narrative is in full swing. Everyone wants to own cell towers. AMT's stock price soars to $240 per share. Your trigger has been hit. Now, you must re-evaluate. You look at their earnings growth, which has been strong. You revise your intrinsic value estimate upwards to $170 per share.
4. Step 4: The Decision. Your new trigger point is $170 * 1.5 = $255 per share. The current price of $240 is very close but hasn't quite crossed the line. You decide to wait. A few months later, in early 2020, the price hits $260. Now your rule is active. The business is great, but the valuation is extreme. The margin of safety is gone.
5. Step 5: Execution. You execute your plan, selling one-third of your shares at $260. You've more than doubled your money on those shares. You still hold the other two-thirds, confident in the long-term business but having significantly reduced your risk from the stock's frothy valuation. The cash from the sale is now ready to be deployed into the energy or financial sectors, which were deeply out of favor and undervalued in early 2020. ¹⁾

• Systematic Risk Reduction: Its primary benefit is converting paper gains into real cash while reducing exposure to a single, potentially overvalued stock.
• Behavioral Guardrail: It provides a logical defense against the powerful emotion of greed, which often tells investors to hold on for every last penny of upside, exposing them to huge reversals.
• Improves Capital Allocation: It forces an investor to constantly ask, “Is this stock still the best possible use of my capital, or could the proceeds be invested in something with a better risk/reward profile?” This is the essence of opportunity_cost.

• Selling a Generational Winner Too Early: This is the biggest risk. If you had applied this rule to a company like Amazon or Apple a decade ago, you might have trimmed a position that went on to multiply many times over. It can cap the “homerun” potential of an investment.
• Tax Inefficiency: Selling a winning stock triggers capital gains taxes, which creates a drag on compounding. This must be weighed against the risk of a major price correction.
• Dependent on Accurate Valuation: The entire process hinges on your ability to estimate intrinsic_value with a reasonable degree of accuracy. If your valuation is too low, you will consistently sell too early. This highlights the importance of staying within your circle_of_competence.

• margin_of_safety
• intrinsic_value
• mr_market
• portfolio_management
• opportunity_cost
• circle_of_competence
• diversification