5i Research Blog
Aug 11, 2013 Selling Too Early Might Be A Mistake: Five Things To Consider First
One of the biggest investor mistakes is selling too early. After all, you will never own a life-changing 20-bagger stock if you sell after that first double. Sometimes, of course, you need to sell. Sometimes you should sell.
Once in a while, though, with a truly great stock, you should not take early profits. It isn't easy fighting that urge to make money, so here are five issues to help you consider not selling. Keep them in mind the next time one of your stocks doubles or triples. Maybe, just maybe, it is on its way to doubling or tripling again.
Market capitalization growth
As companies grow to different market values, their potential audience of investors widens dramatically. Simply put, a larger company is more valuable to investors, because of liquidity and perceived risk reduction.
Often, as stocks cross certain thresholds, their valuation multiples increase. These market limits are not cast in stone, but in general there are two significant barriers.
First, at a $100-million market cap, companies gravitate out of the micro-cap space, and liquidity becomes good enough for small funds and institutions to participate. A bigger market-cap impact generally comes at $1-billion. At that level, all sorts of new investors start checking in and stocks can keep moving as these investors come in and value the companies more highly.
Two examples: Sylogist Ltd. (SYZ/TSX-V) recently passed the $100-million barrier and hardly looked back. Its shares are up 220% in the past year. Alaris Royalty Corp. (AD/TSX), meanwhile, is up 45% in a year. Its market value is quickly approaching $1-billion, and might be one to watch.
Earnings growth versus stock-price growth
Sure, you might have a stock that is doing well, but how are the company’s earnings? They might be accelerating even more than the stock.
Constellation Software Inc. (CSU/TSX), for example, is up 31% this year. Its recent operating income, however, rose 39%. Some investors might argue it is cheaper now than in January because of its rapidly rising earnings. Make sure you consider earnings trends before selling.
Market valuations and outlook
One of the best ways to make money in the stock market is to own a fast-growing company at a time when overall market valuations are increasing.
Suppose you own a company whose earnings are expected to double. If the market is strong, and valuations double, then, voilà, your stock should quadruple, as higher earnings are more highly valued with an improved market.
Right now, the market is doing well, at least in the U.S. But we are hardly at the stage of accelerating earnings multiples. If valuations begin to increase, which is quite possible, the last thing you should want to do is sell.
Earnings momentum and surprises
Why did Facebook (FB/NYSE) suddenly surge 30% in late July after being in the doghouse since its IPO? Well, the company surprised analysts and investors with much faster mobile growth than expected. Since that surge, Facebook shares have tacked on another quick 15% gain.
When a company you own surprises to the upside, do not be in a rush to sell. Analysts fall all over themselves trying to extrapolate new growth rates and tend to raise target prices. Investors who hated the company before now have a reason to look at it again. Short sellers have a reason to cover. It’s all good with positive surprises.
One of the easiest data points for investors to uncover is profit margin. Look for signs of improving gross and net margins. If a company can become more profitable, and its sales increase as well, you might have a nice long-term winner, with higher profits for each incremental dollar of revenue.
In general, when companies are focused on improving margins, it is not a one-quarter event. Improving margins can’t, of course, go on forever. But you might be surprised at the stock impact that occurs from simply running a business better.
Even if all five points are in your favour, it won’t guarantee success. Before selling though, they are worthy of consideration. If a company hits on all of them, however, you might want to buy even more instead of selling.
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