The media is full of stories about stocks to buy now. Less considered is when to take profits in high-performing companies and dump underperformers.
Great investors have a knack of cutting losses early and letting profits run. They spot good opportunities and ride them for as long as they can, maximising returns. Inexperienced investors often take profits too early, believing the gains are over.
I recall buying a 5 cent mining stock in the early ‘90s when I worked in financial markets and dabbled in trading. When the stock leapt to 20 cents, I quickly sold. Having congratulated myself for a fourfold gain, I watched the stock rally to $3 over the next few years.
Had I “let the trend be my friend”, as traders put it, the stock would have increased sixtyfold. I may not be writing this column today had I let the profits run on that mining stock!
The point is, investors have a habit of giving up on great stocks too early. They confuse price with value. The price soars, so the stock is no longer good value. That is true in many instances, but great companies justify their valuation with higher earnings.
Look at Seek, REA Group, Carsales.com, Domino’s Pizza Enterprises, TPG Telecom, Magellan Financial Group and other top performers. The stocks always looked expensive on valuation metrics such as Price Earnings (PE) multiples, but kept rising.
Investors simplistically assumed a PE of 30, 40 or 50 for these stocks was insane, but underestimated the magnitude and consistency of their earnings growth.
I thought about the challenges of taking profits in higher performers after studying several earnings results in the current profit-reporting season.
Three stocks I have been bullish on for The Bull in the past two years – Nick Scali, oOH! Media – NEXTDC – delivered better-than-expected profits. Each has rallied sharply this year and some investors will be itching to take profits. Is it time to sell?
Before each stock is considered, a suggestion: always talk to a financial adviser or do further research of your own before selling (the same applies when buying stocks). That’s not a cop-out, but recognition that selling high-performing stocks triggers capital gains tax events and must be considered in the context of one’s portfolio, which is impossible to do here.
Early investors in Nick Scali, oOH! Media and NEXTDC might take some profits, start to reduce their exposure and reinvest in undervalued stocks. But I wouldn’t be giving up on any of these stocks: they earned their re-ratings and can go higher over the next few years.
Nick Scali, one of the market’s best small-cap stocks, leapt more than $1 after its full-year result, released on August 11. The furniture retailer reported 30 per cent growth in revenue to $203 million and 56 per cent growth in Earnings Before Interest and Tax in FY16.
Like-for-like sales rose a whopping 11 per cent in a challenging retail environment. Gross margins were slightly higher despite the lower Australian dollar (which lifts Nick Scali’s import costs). Management said strong trading conditions in FY16 had continued into July.
Nick Scali is superbly managed, has low debt and plenty of balance-sheet firepower to grow through acquisitions or store openings. It can expand in New Zealand and further improve efficiencies through its new warehousing facility in New South Wales.
Chart 1: Nick ScaliSource: The Bull
Out-of-home advertiser oOH Media! has rallied from a 52-week low of $2.48 to $5.12, cementing its reputation as one of the market’s best Initial Public Offerings in the past few years.
oOH’s first-half earnings for FY16 beat market expectation: revenue rose 18.2 per cent to $146.6 million and underling earnings (EBITDA) leapt 32.7 per cent to $26.8 million.
However, the earning guidance downgrade from rival APN Outdoor, and subsequent share-price fall, suggests weakening industry conditions after the Olympics, which boosted outdoor advertising. But oOH! Media has the market’s best portfolio of digital outdoor assets and some brokers believe its earnings guidance for FY17 was conservative.
It would not surprise if oOH! Media gave back some recent price gains given the extent of its rally and market concerns about a slowdown in outdoor advertising. That could provide a buying opportunity at lower prices for investors with a long-term outlook.
The outdoor advertising segment has good prospects as the digitisation of billboards creates more marketing opportunities, takes ad dollars away from TV and, to a lesser extent, the print media, and provides higher profit margins for out-of-home advertising providers.
Chart 2: oOH! MediaSource: Yahoo
Data-centre operator NEXTDC, a favourite of this column, has soared from a 52-week low of $2.19 to $3.97 as it moves into a period of strong profit growth.
The Brisbane-based company reported 52 per cent growth in revenue to $92.8 million and 247 per cent growth in underlying earnings (EBITDA) to $27.7 million in FY16. Contracted utilisation at its facilities leapt 20 per cent over the financial year.
Its FY17 guidance of $46-$50 million in underlying earnings was stronger than the market expected, hence the share rally. Business profitability is rapidly rising as NEXTDC benefits from greater operating leverage across more sites and higher capacity utilisation.
As I have written previously for The Bull, the data-centre industry has a solid outlook as more companies store data offsite and as the so-called “Internet of Things” vastly multiplies the amount of corporate data collected, analysed and stored offsite.
The market underestimated the barriers to entry in NEXTDC’s data centres; these are not easy assets to replicate, especially in congested capital-city locations.
Like Nick Scali and oOH! Media, NEXTDC is due for a share-price pullback or consolidation. It, too, has good long-term prospects for investors who can see how earnings growth will quicken in coming years, justifying a higher valuation multiple and further share-price gains.
Chart 3: NEXTDCSource: The Bull
Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without taking into account your objectives, financial situation or particular needs. Before acting on the information in this article you should consider the appropriateness of the information, with regard to your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at August 24, 2016.