When good stocks don’t have great prices
Look toward the New Year with caution, say these Canadian small cap specialists, who find that many stocks they like are now overpriced.
As the year ends, many investors sell up and take profits.
It’s a little late to be doing that for 2009 — there are probably a few New Year’s parties starting already, at least in the east.
But the turn of the year is generally a good time to re-assess one’s portfolio, deciding what to keep and what to wrap up. And since the market has been pretty boisterous these past nine months, many a stock is up.
Still, the decisions aren’t always easy. When does a good stock become too good? When is it time to say farewell to a winner? When is it time to hang on and ride it a little longer?
For a few answers, we’ll turn to a group of Canadian experts who specialize in small cap stocks. KeyStone’s Small-Cap Stock Report is put out by an independent research team, and its editors can be counted on not to err on the side of optimism.
Decisions on individual stocks can scarcely be made without taking a good hard look at the market. These experts do just that, and then tell us how they propose to treat stocks whose prices have been pushed up.
They illustrate with two stocks they like very much. One is now a hold. The other is a sell.
Cringing a bit
“Most market players are feeling quite good about themselves right now and the bullish sentiment continues to make the value investors in us cringe just a bit,” say the editors of this advisory.
What worries them most is that fundamental financial strengths are being pushed into the back seat. The rallying cry is liquidity. Stimulus spending and cheap capital will splash over the markets and lift equities.
All that cash parked in money market accounts is surely ready to pounce on the markets, so they can’t go anywhere but up.
“The problem is we heard the same liquidity talk during the peak of the bubble in 2007. The reality is that the mountain of money is no lower or higher than it was when the market was scraping new lows in 2008,” the editors state bluntly.
In short, there was just as much money on the sidelines during a time of unbridled optimism as there is now at a time of greater uncertainty.
Shrinking GARP
You may have heard of Mr. David Rosenberg. This Canadian analyst, who returned from a stint with Merrill Lynch on Wall Street to Gluskin Sheff in Toronto, is much listened-to on both sides of the border.
Mr. Rosenberg, the editors tell us, has carefully studied price/earnings multiples at times when the economy is turning from contraction to expansion. Historically, they have been half of what they are today.
“What this tells us is to continue to be cautious and take profits where warranted and be very selective in our buying,” they say. “We are now somewhat fearful as others get greedy — but we will not panic.”
That doesn’t mean there aren’t good stocks out there among the small caps they follow, or as they put it, GARP stocks. That acronym stands for Growth At Reasonable Prices, they explain, although the “G” could also stand for Great Companies.
However GARP is defined, they add, the bottom line is that the number of favourably priced stocks is declining.
A great, well-run company
Here’s how that works out with one of this advisory’s top stocks of the past two years. Alliance Grain Traders (TSX-AGT) has been a Focus Buy since August 2007. This Saskatchewan firm is a processor of specialty crops like lentils, chickpeas and beans.
Originally recommended at $6.65, it earned another “buy” call this past March at $8.00. Subsequently it has surged all the way to $29.
“Alliance Grain is what we would classify as a great, well-run company which displayed tremendous growth financially as well as in its stock price over the past year.” But the shares up well over 300 per cent since the first recommendation and over 250 per cent since March, while revenues and earnings have tracked down in consecutive quarters.
So the advisory has recommended selling half of the original position. The other half remains a hold for the long term.
“While we believe in riding out our winners, if a company gets ahead of its financials and tremendous gains have already been made, it becomes greedy to not take at least some of your initial position off the table.”
By the way, Alliance also has a 54¢ dividend yielding 1.8 per cent.
Looks like a buy
Another stock that has soared is China Sky One (NASDQ-CSKI). This firm makes and distributes Chinese branded medicines. Its shares are up over 80 per cent this year (it trades at $22 and has no dividend).
Thus the company’s shares “are no longer as cheap as they were,” say the editors, “but given the guidance going forward, they are not what one would classify as expensive.”
The company continues to strengthen its balance sheet and is poised to grow through acquisition. So it still looks like a solid buy. But it’s a sell.
A few red flags have been raised. First, China Sky admitted that it had underreported the income of its Chinese subsidiaries. It will pay a penalty, although it claims this will not materially affect the company. Still, it has not explained why one segment of its statements was wrong.
Red flag number two is a little more vague, but worrying nonetheless. Short sellers have started to question the efficiency of the company’s big money maker, a weight loss patch.
While the short sellers seek to promote the downside of things, this advisory reckons it’s time to take profits and remove any risk.
So China Sky, which was a hold, now becomes a sell. “We are happy to take our strong profits off the table at these levels and employ them elsewhere,” conclude the editors.
All successful stocks are not alike, these experts insist. Each must be examined carefully when it comes to deciding whether to buy, hold or sell.
And the best we can wish you for the New Year is that your toughest decisions will be what to do with your successful investments.
Happy New Year. We’re back on Monday.
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