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Deciding when to sell

To take profits or not to take profits? If Hamlet were an investor, that is the question he would ask. Hamlet was no money man. In fact, it was probably Antonio’s creditor, Shylock, in The Merchant of Venice, who would be working out the best financial path. Then again, Shylock coined the expression, “a pound of flesh,” which might be equally appropriate when talking about taking risk off the table by turning it into cash.

This is, after all, a luxury every investor wants to have. It is an important factor to consider as you review your portfolio.

Selling is often where you have no choice

On the other hand, selling is something you do rarely, and it is of necessity: whether you have lost confidence in management, the company’s business model; in the board’s strategy, or there are serious balance sheet questions. This is a decision of greater magnitude because it is a more drastic measure. You sell if you have high conviction that the stock price will turn south, whether or not you are sitting on a profit. There is never a wrong price to get out of a company that goes broke (remember RCR Tomlinson?).

Taking your costs out and letting your profits run

At Under the Radar we often use the phrase: “Take your costs out and let your profits run.” In other words, “take some risk off the table”. This is crucial especially in the small cap world, which we define as ASX listed companies with market caps below $500m. Small caps fly closer to the wind than their bigger counterparts, which is to say that when they fall on hard times, there is more likelihood that they can go broke. We saw this during the financial crisis and it is also evident by their higher volatility – on average they have bigger highs and bigger lows. Also, small caps often don’t pay dividends, so the only way to get cash returns is to sell some stock.

The importance of taking profits was made clear to me when the marketing department asked me to list our 10 biggest winners and losers after eight years of editing Under the Radar Report. I had a look at our top 10 winners from our five-year anniversary three years ago. We then compared those returns to how the stocks have gone over an eight-year period. The graphic below clearly shows that it was better to take profits.

Graphic 1 – Performance of top 10 winners from 2016

In particular, ImpediMed (IPD) had delivered an eight-fold return and fast forward to today and you are losing money. For all the big returns you have made on Northern Star Resources (NST) and to a lesser extent Nick Scali (NCK) and Freedom Foods (FNP) you would have done better if you’d simply sold out five years ago.]

Under the Radar’s case studies

When the market was in freefall last December, we showed Under the Radar Report: Small Cap subscribers case studies of some 21 stocks that we had taken profits on, emphasising that you need to take your costs out and let your profits run when times are good. We detailed how we had achieved an average cash return on these stocks of 160%, during the five year period to late 2018. During that period the ASX Emerging Companies Index  only just climbed above breakeven. Taking profits monetises gains and reduces volatility. But it’s all about timing.

What to think about right now                

Right now the domestic market is showing buoyant signs following the LNP victory in the Federal election on 18 May. A lot hinges on the August reporting season because earnings multiples are starting to become stretched from reality. If the economy improves and company turnarounds are confirmed, then this will be the validation the market needs to justify current valuations. On the other hand, if it falls short, watch out! All you need is a Trump trade tweet on top of a weak earnings announcement and you might find yourself sitting on unexpected losses.

Because every case is different, below are three of those case studies and each is also a stock in which we have a current take profits recommendation.

Case study 1

BISALLOY STEEL (BIS)

CASH RETURN: 74%

TAKE PROFITS

INDUSTRY

STEEL MANUFACTURING

WHY WE TOOK PROFITS: We were positive too early in a stock that got hurt by the financial crisis and associated commodities downturn. Consequently, having advocated buying the stock above $1, we downgraded to hold at $0.85
in July 2013 due to flattening demand from China.

Then, when we saw demand improving and dividends being paid again, we upgraded to a spec buy at $0.86 in August 2013. However, the rating was cut to hold in September 2014 at $0.36 as challenging trading conditions continued to hurt performance leading to a cut in the dividend in FY14.

We held on and upgraded to spec buy on signs of improving performance in October 2015 buying at prices ranging from $0.364 to $0.60 until August 2017. Our rating was lowered to hold in September 2017 at $0.74 following the sharp rise in the price around that time. We have been taking profits since the share price approached $1.00 in March 2018 given the risk and uncertain prospects of a dividend.

MARKET CAP

$42M

NET DEBT

$13M

DIVIDEND YIELD

4.2%*

PRICE @ 6/6/19

$0.945

ORIGINAL TIP DATE

4/12/12

ORIGINAL TIP PRICE

$1.27

*FY19 forecast

Case study 2

INFOMEDIA (IFM)

CASH RETURN: 348%

TAKE PROFITS

INDUSTRY

AUTO PARTS CATALOGUES

WHY WE TOOK PROFITS: We have made money from this stock a couple of times. The stock was initially covered in June 2013 at $0.47 with the belief the price would head towards $1.00. We moved to hold in February 2014 at $0.76 on valuation grounds and with the valuation looking stretched, we took profits during February and April 2015 at $1.14 and $1.26.

When the price retreated our rating was upgraded to hold at $0.82. The share price fell further on missed guidance, board disunity and loss of the CEO in 2015, prompting us to upgrade to buy in March 2016 at $0.55. We bought up $0.83 before taking profits at $1.245 in August 2018 with the stock trading at a PE over 20 times.

MARKET CAP

$559M

NET CASH

$8M

DIVIDEND YIELD

1.9%*

PRICE @ 6/6/19

$1.70

ORIGINAL TIP DATE

13/6/13

ORIGINAL TIP PRICE

$0.47

*FY19 forecast

Case study 3

MEDICAL DEVELOPMENTS (MVP) CASH RETURN: 491%

TAKE PROFITS

INDUSTRY

SPECIALTY PHARMA- CEUTICALS

WHY WE TOOK PROFITS: We love the business model of Medical Developments, which is why we first held on for so long. We first rated the stock a buy at $1.18 in May 2014. Since then the company has been profitable and cash flow positive every year since listing in 2003 and used that cash to fund registrations and additional clinical studies. Since then it has paid 26.25 cents in fully franked dividends.

The stock has traded towards $8 in early 2018 but we have taken profits a couple of times, most recently at $5.22 in October 2018, having been buyers again at close to $4 when the company undertook one of its capital raisings earlier that year. Part of investing is recognising when you have had some luck on the timing front. We got it right this time and we waited for an opportunity to upgrade, which paid off handsomely, having bought at $3.71 late last year to take profits at current levels.

MARKET CAP

$340M

NET DEBT

$8M

DIVIDEND YIELD

0.8%*

PRICE @ 6/6/19

$5.20

ORIGINAL TIP DATE

14/5/14

ORIGINAL TIP PRICE

$1.18

*FY19 forecast

Special trial offer: nabtrade customers are invited to take up a six-week free trial to Under the Radar Report.  

Richard Hemming is Editor of Under the Radar Report (AFSL 409518). All prices and analysis at 5 June 2019. This information contained on this website is general information only, which means it does not take into account your investment objectives, financial situation or needs. You should therefore consider whether a particular recommendation is appropriate for your needs before acting on it, and we recommend seeking advice from a financial adviser or stockbroker before making a decision. All information displayed on the website, is subject to change without notice. UTRR does not give any representation or warranty regarding the quality, accuracy, completeness or merchantability of the information or that it is fit for any purpose. The content on this website has been published for information purposes only and any use of or reliance on the information on this website is entirely at your own risk. To the maximum extent permitted by law, UTRR will not be liable to any party in contract, tort (including for negligence) or otherwise for any loss or damage arising either directly or indirectly as a result of any act or omission in reliance on, use of or inability to use any information displayed on this website. Where liability cannot be excluded by law then, to the extent permissible by law, liability is limited to the resupply of the information or the reasonable cost of having the information resupplied. No part of UTRR's publications may be reproduced in any manner, and no further dissemination of its publications is permitted without the express written permission of Under the Radar Report Pty Ltd. Whilst all reasonable care has been taken by WealthHub Securities in reviewing this material, this content does not represent the view or opinions of WealthHub Securities.