It’s a horrible decision to have to make. You buy into a stock and watch it soar as the story takes off. Then you have to make a call… do you run your profits, or take some chips off the table?
On the one hand you are looking at 200% or 300% gains. Why not take the profits? But then of course you’ve become a little emotionally involved in the story. And you have a strange feeling that this stock could run and run.
The decision can be agonising – is there ever a right time to cash in your profits?
That’s the question I want to deal with today. It’s one that has been vexing quite a few Right Side readers recently as gains on a stock I tipped in March hits nearly 300%.
Today I want to run through the classic emotions that investors feel as a stock cuts loose. I want to show you how to make the tough decisions necessary for a profit – and why it usually pays to overcome your emotions.
Keep climbing higher & higher – Temptation
(Heaven 17, 1983)
When I invest, the general idea is that I buy for the long term. I have ‘trading stocks’ too – where I’m relying on the charts to deliver me a quick return. But most of my core portfolio is bought on a buy and hold basis.
But sometimes, things go so well – much better than anticipated, that the stock starts to needle away at me – urging me to cash in some winnings.
And that’s exactly what’s happened with Supergroup PLC (LON:SGP). These are the guys that own the clothing brand Superdry (amongst others). They’re expanding quickly and sales have been roaring away.
SGP floated at £5 in mid March and has been climbing ever since. Now the chart that follows is great. And it’s not just because of its nice upward trajectory, it’s because of the classic bull-run pauses along the way. This is where temptation starts to prod and poke at you and where investors need to be careful.
Before the float (when the shares are offered to the public), I outlined my reasons why I thought this was a great opportunity. If you missed it, it doesn’t matter, there’ll be others. And anyway, there’s plenty to learn from this chart.
The chart tells a classic bull story. Three major inflection points will have given holders something to think about. And even as we look at the chart today, it’s testing shareholders nerves again.
Each time the stock comes off the boil, you’re left wondering “is that it… is the bull-run over?”
After six weeks, investors were up over 20% – and that’s not to be sniffed at. It would have been easy to take the money off the table and look for another investment.
But if you held on, after four months you were up 100%. A cracking return during what was a turbulent time in the markets. But then again.
As of today, a mere eight months into the story, initial investors are sitting on a profit of nearly 300%.
So, would you have held on? And if you did, is it time to cash up?
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Let the fundamentals guide you
The classic way to trade such a bullish chart is to buy more stock as it moves up. BUT, as I outlined above, every sinew of your body is telling you to cash in a profit.
So when I wrote to readers in the middle of June, saying the SGP chart was telling me ‘It’s never too high to buy’… the stock was just under £7 (i.e. nearly 50% higher than the float price) some readers thought I was mad.
But the chart was doing the talking and that’s what you should be looking at. For confirmation of the chart action, it’s useful to look at the fundamentals.
The final results were released in mid-July, showing sales up a whopping 83% to £139m and profits rising from £8m to £26.5m. No wonder the stock was soaring.
And they’ve continued at pace. The latest figures show quarterly sales of £90m. So, if that figure is representative, it translates to annualised sales of £360m. Goldman Sachs (who admittedly are bullish) forecast earnings nearly doubling for this year to £49.5m and climbing to £75m next year.
| 2009 | 2010 | 2011 (est) | 2012 (est) |
|---|---|---|---|
| £8m | £26.5m | £49.5m | £75m |
So, business is booming.
But remember, so is the share price. The stock is now worth some £1.1bn, giving us an historic p/e of just over 50x. That’s the sort of multiple that usually makes me run for the exit.
You can halve that (to 25x) if Goldman’s figures are right for this year. And then keep on reducing it for how much you reckon SGP will continue to grow.
So what should you do?
Time to top-slice
Sometimes it simply pays to take some chips off the table. Especially when the fundamentals (25x earnings) are asking a lot of the stock.
In this case, cashing in a third of the holding will (more or less) give initial investors their investment back. That still leaves 2/3rds riding. If SGP continue to deliver, you won’t be upset as you watch your holding ratchet up. And if SGP slips up, you’ll be pleased to have taken some profits off the table.
And there’s another reason, too. Say you allocated 2% of your funds to this trade, your investment could now make up around 6% of your portfolio. In the interests of diversification, we should rebalance the holding. This way we’ve pared it back to around 4% and that’s more than enough in any one stock – even when the chart is looking strong.
Action to take: Top-slice Supergroup
• This article was first published in the free investment email The Right side. Sign up to The Right Side here.
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