When to buy stocks and when to take profits
Even before the market correction, these Canadian small cap stock specialists were taking some profits. But there are still buys out there.
“As we suspected, the markets have been looking for an excuse to sell off or take profits.”
The markets found a darn good excuse — the possible collapse of the European monetary system and all the chaos that could bring.
Our opening quote comes from a group of independent Canadian researchers. They are explaining to their clients just why they have made so few buy recommendations in the past few months.
In fact, they have taken profits on some of their favourite stocks. But the team that publishes KeyStone’s Small Cap Stock Report is still issuing a few strong buys. And it is far from giving up on the stocks it likes.
It’s simply time to sit back and take stock of the situation.
A necessary correction
In the six months following the 2008 stock market crash, these small cap specialists issued 15 buy reports.
In the past three months, they have made just two.
The advisory’s clients (both institutional and retail) have been asking for the thinking behind this cautious policy.
“To this, we have answered that the markets have appeared pricey for quite some time and a period of consolidation or a correction was likely necessary, given the tremendous run we have seen year-over-year and the valuations we were faced with.”
And so it came to pass. The market corrected early in May (aided by chaos in the electronic trading systems) and again later in the month.
But it wasn’t just the spectre of a correction that caused these researchers to be cautious. There just weren’t as many good buying opportunities in an overpriced market.
A lifelong endeavour
“The investment process is a lifelong endeavour,” says the advisory. “To be successful in the long term, it is sometimes necessary to know when to be selective and when to be more liberal with our buying. Fortunately, the fundamentals often guide very well in this respect.”
Over the last six months, it has become increasingly difficult to identify value. So these researchers have acted accordingly, following half of the famous dictum of Mr. Warren Buffett — “becoming fearful as others became greedy.”
They advised their clients to sell half or even all of their positions in four successful stocks.
We reported on these stocks six weeks ago (see Daily Buy-Sell Adviser, April 22), but we will update them today, since the advisory still considers them excellent companies for the long run. They like “the businesses and the management teams” of all four.
Plus a fifth favourite stock has been added to the “take profits” list.
Four plus one
The four stocks on which profit taking was suggested back in April have all trended down since. None pays a dividend.
Asia Bio-Chem Group (TSX/V-ABC) makes cornstarch and has opened a major plant in Daqing. The shares rose as high as $1.70 earlier this year and now sit at $1.23, down slightly in the past month.
Bridgewater Systems Corporation (TSX-BWC) makes the software that lets people log on to their cellphones and other networks. It rose from less than $4.00 to $11.60 in less than a year. It’s now at $8.95.
Sino Forest Corp. (TSX-TRE) owns and manages large forest plantations in China. A year ago it was less than $10. In March, it reached $21.74. It now trades at $17.69.
China Agritech Inc. (NASDQ-CAGC), a Chinese fertilizer maker, made a spectacular run. From $2.20 in April 2009, it rose above $30 in March. It is now back to $12.87.
Now a fifth firm joins the list. The advisory recommends that investors sell half of The Cash Store Financial Services Inc. (TSX-CSF).
Based in Edmonton, this company is one of the strongest chains in the so-called “alternative financial services market.” In effect, it offers advance payday services, mostly in the form of loans.
The stock rose from less than $10 in December to a high of $18.74. It now trades at $15.86. Unlike the four stocks above, it does pay a dividend, yielding 2.5 per cent on the $0.40 payout.
Ready for opportunities
Caution doesn’t mean passing up good buys. And these researchers are sitting on a good deal of cash in their Small Cap portfolio (as you should be after taking profits the last few months, they tell their readers).
Thus they are ready for the opportunities that do present themselves. For this advisory, they often come from China. Some fear a slowdown in China these days, but these specialists think a cooling-off in its economy would be a good thing in the long term.
In the meantime, they see a bright opportunity in a recent Focus Buy. Zungui Haixi Corp. (TSX-ZUN) makes athletic footwear, casual leather footwear, apparel and accessories.
Trading above $3.00 a month ago, it has slipped, but not greatly, to $2.92. It has posted solid earnings per share over the past year and its trailing P/E ratio is less than 7. It does not pay a dividend.
“In times of turmoil, we also look to businesses that produce strong cash flow and good yields to wait out the storm,” say the researchers.
Two income trusts fit that bill, they add. Collision repair firm The Boyd Group Income Fund (TSX-BYD.UN) is trading at $4.75 and yields 6.6 per cent on a 32-cent distribution.
Hospital and hotel linen supplier K-Bro Linen Income Fund (TSX-KBL.UN) trades at $14.77 and yields 7.5 per cent on the $1.10 distribution. Both become “attractive long term on pullbacks,” says the advisory.
From fear comes opportunity, says this advisory. When a frightened market sends good companies down, it is time to stop being fearful, and get greedy again.
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