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 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