When to let good stocks ride and when to cut your losses
You should cut your losses quickly, says a Canadian analyst, but make a careful decision on profits — he illustrates with two Canadian stocks.
The stock market should be going up.
After the mid-term elections in the U.S. — which turned out pretty much as expected last night — the market usually rises.
We got a detailed report on this phenomenon last week (see Daily Buy-Sell Adviser, October 25). If history repeats itself, investors will have many interesting decisions ahead.
Yesterday, we got advice on when to sell. Today the theme is similar — when do you let your profits run and when do you cut your losses.
Our guide is Mr. Sudhir Dhawan, an independent analyst who writes frequently for Investor's Digest of Canada.
His advice is concise. “Be quick with your losses and let the profits run.”
Mr. Dhawan expands on this theory and puts it to work with two stocks that have done well for him.
Should he take profits or let ‘em ride?
The desired result
Mr. Dhawan has a rule of thumb for investment losses. “Taking a loss should be automatic after a 10 to 20 per cent decline depending on the type of security.”
In other words, you might stick with a larger stock below the 10 per cent level in hopes of recovery, but let go of smaller, less well-heeled stocks before they fall too far.
“To pay for the inevitable losses, we need to maximize our gains but that does not mean selling at the top,” says the analyst.
The decision is based on the strength of the individual stock. “Depending on a company’s growth prospects, along with some luck and lots of patience, should give us the desired result.”
Up to now, he has had a desirable result with two picks he made in 2009. Now he must decide when to sell. “They are both growing but at the same time they also face many challenges.”
Leader in loyalty
Groupe Aeroplan Inc. (TSX-AER) is a real growth story, says Mr. Dhawan. He recommended it at $9 in March 2009. It had reached $12.15 when this article went to press and trades today at $12.32. It also yields a healthy 4 per cent on its $0.50 dividend.
An income trust for several years, the company converted back to corporate status as early as 2008. Its objective is “to become a world leader in loyalty marketing,” states the analyst. In 2007, it bought Loyalty Management Group in the U.K., which owns Nectar. With 10 million members, it’s the biggest program in that country.
Nectar owns 60 per cent of Air Miles Middle East covering UAE, Qatar and Bahrain, a lucrative market. Earlier this year, it launched Nectar India.
In November 2009, Groupe Aeroplan made another big acquisition, Carlson Marketing in the U.S. Carlson, too, has just opened an office in India, working with upscale Indian airline Kingfisher.
Not surprisingly, Aeroplan’s revenues shot up in the first six months of the fiscal year, to the tune of 42 per cent. The company brings in lots of cash that it funnels into more growth.
It has put some of that cash into a share buyback plan that will end in May 2011 and has already reclaimed five million shares.
Air Canada still accounts for about 18 per cent of Aeroplan’s revenue, and it plays an even more important role in reward redemption. But it’s also a source of uncertainty.
“As the economy improves, Air Canada’s prospects are getting better,” writes the analyst, “but it is a very cyclical business.”
Mr. Dhawan is letting the profits run on Aeroplan. “The growth prospects are worth the risk.” And the most enticing prospects lie with the newly affluent populations of emerging nations like India.
In the vineyards
Now we travel to the vineyards of Ontario’s Niagara Peninsula. Andrew Peller Ltd. (TSX-ADW.A) was recommended in April 2009 at $6.79. It rose to $8.90 when the article was written and stands today at $8.76. It has a nice yield, too, at 3.7 per cent on a 33¢ dividend.
The company was once known for its popular (and popularly priced) Andres wines, but for several decades it has also prospered with premium wines. In addition to its original Niagara home, it now has wineries in British Columbia and Nova Scotia as well.
Sales increased in the last fiscal year, but they were flat in the most recent quarter. Sales of wine kits have been flat for some time.
Profit margins have improved with a boost from the Canadian dollar, however, and earnings per share rose in the last quarter.
Class A shares earn a higher dividend, but they are not eligible for a premium if and when the company becomes a takeover target, since they are non-voting shares. Ontario’s harmonized sales tax is also not doing Andrew Peller any favours in its company-owned stores, either.
Still, this stock is undervalued. The book value of $7.80 “probably does not reflect the true value of prime real estate and vineyards owned in the Niagara region and in British Columbia,” Mr. Dhawan tells his readers in Investor's Digest of Canada. “With shares trading at only a 15 per cent premium to the book value, there is very little downward risk.”
The analyst does have a cut-off point. Undervalued though it is, Peller could be stuck with slow earnings growth (the next quarterly report will be out November 10). Mr. Dhawan will be happy to take his profits at $10.
It may seem as though there’s a lot to look at when you’re deciding what to do with a profitable stock. But one thing stands out.
Earnings drive share prices. So if your stock is likely to earn more, you may want to stick around for the ride.
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