Tuesday, 29 October 2013

Taking partial profits with shares: A sensible strategy

One of the biggest problems that most people have with investing is knowing when to sell and take the profit they have made on their shares.  If you have bought a share which you thought was cheap and you have a significant margin for error built into your valuation the chances are that you will face the problem of having a share that has performed significantly well in percentage return  terms but still represents value in an absolute sense.

An example of how the issue can come about

I recently faced this problem after FKP (a share that I have posted about extensively on this blog) performed very well.  I first purchased FKP, an Australian retirement and residential property stock because it was trading at a significant discount to it's net asset value (NAV).  However not long after I did so they had some serious debt issues and did an equity raising at a significant discount to the stock price.

I participated in the equity raising and managed to get a significant over allocation because of my particular broker (most people got scaled back which was rather annoying at the time).  In the following months the stock performed terribly which was nerve racking because it represented 1/4 of my share portfolio.  Given how low the price fell I would have liked to purchase more but from a portfolio concentration point of view this didn't make sense.

You may wonder why I didn't sell the stock and just take my losses when it was performing so badly.  I had researched the stock well and I believed that the management team was doing the right thing and the news that was coming out was incrementally positive the whole time even though the market was not recognising it as such.  I was keeping on top of my existing shareholdings which is easy to forget to do.

Recently, after more good news the share market finally responded positively to the stock and the stock moved to a point where I had made a ~20%+ return and I was faced with a dilemma...this stock could go up by another 20 - 40% but I had already made a good profit off it...should I sell it or should I hold onto it?

Taking a partial profit allows you to lock in some of your gains

I decided in the example above to sell about 1/3 of my
shareholding and take a partial profit on the shares.  This gave me a nice little gain, however I was still exposed to the upside associated with the stock.  If your valuation says that there is still value to be gained from the stock and you trust this valuation then it becomes a matter of quantum.

After FKP's run I no longer felt comfortable with how much of it I had in my portfolio.  The one stock made up 1/3 of my share portfolio.  By reducing the stake I had, I made this a much more manageable quantity, managed to lock in some of my profits and to remain exposed to the stock.

Taking a partial profit reduces your variability of return.  This means that if the stock goes up you make less (because you have sold out early) and if the stock goes down then you have lost less (because you locked in some profit).  I think it is a sensible thing to do.

Trying to time the top of the market or to time what the market is going to do at any point in time is a fool's game.  Sometimes a stock will never reach your valuation and sometimes it will shoot straight past it.  You should have faith in your valuation (although have a range around this - your assumptions will never be perfect) but trying to gain every last cent of valuation is not a game that I like to play.

You should think about taking a partial profit if:

  • You have other, higher returning, options where you could invest the money
  • You are uncomfortable with the amount you have invested in that stock 
  • You would just like the piece of mind of taking some profit as your bet has partially paid off
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