E-mail this article Printer-Friendly

Taking profits in an unprofitable market

You can’t expect the market to recover fully this year, says this Canadian advisory, but you can still expect to take some profits.

“Nervous volatility” is as good a term as any to describe the market these days.

But describing it is easy. It’s deciding what to do about it that’s hard.

It may be a little easier to act if you have investments that are doing well and your decision is, do I take profits or not?

That is the case for investors who follow KeyStone’s Small-Cap Stock Report, the advisory that used the phrase we led off with. Despite the volatility, this independent research team has had satisfying results with a number of its recommendations.

Now it’s time to make decisions. Buy more, hold or sell. We’ll see how the advisory acts on three stocks and three income trusts.

But to determine how you should act, you must have some idea of where the market might be going and what you want from your investments in the months ahead.

Not all that cheap

The advisory poses two questions. It wants to know if the recent rallies are leading to “a sustainable rally based on anticipation of stabilization in world credit markets.” Will the current recession show signs of a recovery by the fourth quarter or at very least year’s end?

And are the markets still cheap, or at least reasonably priced, following these rallies?

Cheapness comes first. The advisory looks at price/earnings (PE) multiples on the Toronto Stock Exchange. On average, analysts have cut their 2009 earnings estimates by 15 per cent.

With the TSX trading at around 9,120, that means the market is trading at around 11.7 times consensus earnings. With a historical average of 15 per cent, that looks pretty cheap.

Yet in previous recessions, PE’s have been as low as 10. Back in the 1970s, a period often compared to today’s situation, good companies had PE’s down in the 6 to 8 range. The market is not all that cheap, the advisory concludes. There may not be as many good values as advertised.

Be wary

Nor does the advisory believe that relief will come to the economy and the markets by the fourth quarter.

The great de-leveraging is still in progress, and the western world may be paying down debt for years. Until spending recovers, corporate earnings will not recover.

Even when you see “better-than-expected” company results, be wary, says the advisory. These may beat some very low expectations, but they’re not actually good. They can “power stocks forward until investors realize that the results are in fact just bad.”

But the picture is not all bad for this advisory, which is “very happy with the profits we have carved out in the past six months.”

Three sells and a hold

While the TSX was shedding 22 per cent of its value, this advisory saw share prices rise for 13 of its 14 buy recommendations over the past six months. Several made big gains “and there will undoubtedly be further excellent opportunities moving forward,” says the advisory.

“We believe it is prudent to be cautious at the moment and take some of these profits off the table.” In a market you still can’t trust, it’s wise to pocket at least some of your gains.

Thus the advisory issues three sells — on Chinese pharmaceutical firm American Oriental Bioengineering Inc. (NYSE-AOB), specialty crop processor Alliance Grain Traders Income Fund (TSX-AGT.UN) and digital information technology specialist International Datacasting Corp. (TSX-IDC).

Chinese fertilizer firm Migao Corporation (TSX-MGO) gets a more mixed treatment. The advisory has moved it to a hold “and would consider taking profits if one had a short-term outlook. Long term, the buy rating remains intact.”

The advisory is “particularly pained” to put Alliance Grain Traders on a sell, it admits. This company, which cleans, sorts and bags pulse crops — legumes such as beans, lentils and chick peas — has shot up 75 per cent since the most recent buy recommendation.

Near-term investors should take profits, says the advisory, since such a strong move is likely to be followed by a pullback, given the uncertain market conditions. For long-term investors (1-5 years), it continues to rate Alliance a hold.

Still buys

Two other income funds have done very well. Should they be sells, like Alliance Traders? No, says the advisory. And it’s mainly because of the income.

K-Bro Linen Income Fund (TSX-KBL.UN), a linen and laundry firm serving hospitals, health care institutions and hotels, is still a buy. So is auto collision and auto glass specialist Boyd Group Income Fund (TSX-BYD.UN).

Both appreciated “smartly” — better than 30 per cent — in six months. But this is still less than half the appreciation of Alliance Grain Traders.

What’s more, Alliance’s distribution yield, while solid and sustainable, is less than half that of the other two. This does not put it in the “pay us while we wait” category of the other two, says the advisory.

K-Bro yields over 9 per cent and Boyd over 8, “and we can stomach a bit of unit price volatility with such solid yields.” Plus they both pay out monthly and cycling in and out would cost you some income.

A decision to buy, sell or hold is based on any number of reasons, some to do with the investment, some to do with you.

But as long as you know exactly what you need and take a clear view of this treacherous market, you may be among the fortunate few whose main concern is taking profits instead of absorbing losses.