One of the hardest decisions in investing is deciding when to cash in your chips. When and how do you walk away? I’m sure it’s a question that you’ve asked yourself recently. If you are sitting on a sizeable profit, the question probably haunts you.
Well today I’d like to address this crucial dilemma. I’ll tell you about a solution that’s worked for me in recent years. And seeing as I’m in the throes of reducing my bond allocation, I’ll use that asset as an example. Here’s how it works…
What if the stock goes up after I sell it?
There are two considerations when you are deciding to sell – two questions that you have to ask yourself…
First, on a practical note, what’s driving you to sell? What factors determine your exit?
And secondly, how do you cut your position? Sell it all, or exit by selling small chunks over time?
There’s a time and a place for both. Sometimes it can be right to sell it all, and other times I’d definitely consider selling in dribs and drabs. Today we’ll look at both strategies – and when it’s best for each one. Take this bond here…
One-year performance of Enterprise Inns 2018 bond
Source: Digital Look
I first tipped this bond just over a year ago – and as you can see, it’s had a good run. My reason for buying was clear. With interest rates set to stay low for the foreseeable future, we were looking for some decent income plays. And with this bond we were set to receive over 12% a year! That includes both the running yield (ie, what the bond is paying in coupons) and the capital gain when the bond matures at the end of 2018 (assuming Enterprise is still in business by then).
Given that this bond is secured by a mortgage over a property portfolio worth twice as much as the bond issue itself, my feeling was that it shouldn’t be paying out anything like 12%. Therefore it was a fantastic buy.
It now turns out the market agrees. With the bond trading at about £1 (what we call par), it yields 6.5%. That’s much more sensible!
The decision to sell is now relatively straightforward. 6.5% is a reasonable enough yield – but it’s not enough for me to stick with the bond. I’m inclined to sell the lot.
But I did say that there’s also a time to sell a stock in dribs and drabs. So let’s look at that:
Enterprise Inns share price over the last year
Source: Digital Look
Though I didn’t recommend buying shares in Enterprise Inns, in reality they’ve performed even better than the bonds. The shares have motored up from around 30p to over £1.
But the problem with the shares is they’re much harder to value than the bonds. There’s no dividend – so you can’t value it in terms of income… any income considerations come down to as and when the dividend may be reinstated.
And in terms of growth, well the pubs game is generally in negative growth! These guys are more into selling pubs than building the business up. In fact, it’s selling the pubs that’s improved Enterprise’s liquidity position, which in turn has put a rocket under the shares.
Hypothetically speaking, if I had held the stock, my approach to exiting the position would be to sell down the position in thirds. With shares so much more difficult to value than bonds, I wouldn’t want to be so forthright as to say “sell the lot”.
Had I bought at 30p, I would have sold one third of my holding as the stock hit 60p. The fundamentals of the business hadn’t changed that much. And the stock was always at risk of sliding back.
A 100% gain in a matter of months would have triggered some profit taking on my part. And, as it happens, I would have been both right and wrong. Yes, the stock continued to motor… it’s a shame that I’d cut my exposure. But then again, I still would have had two thirds riding. And as part of the strategy, I would have sold another third as the stock hit 90p.
Remember, that second lot would have made me a 200% gain!
As for the last third, I’d still be sitting on it.
The point is, shares can be a devil to value. Even the best analysts can’t really say with much conviction where a share price is heading – and therefore when is the best time to sell. There’s an awful lot of randomness involved. It would be very conceited to suspect that you can work out the best time to get in or out of your stock. That’s why it’s usually best to phase your way in and out.
But when it comes to bonds, the position is much more black and white. It’s a matter of working out the yield to maturity (ie, what the bond pays in income and capital upon maturity) and deciding whether the bond is a good credit risk.
Ultimately, you can be more confident in your decision making with a bond. To my mind, it isn’t conceited to say that it’s time to sell Enterprise bonds. It’s a simple statement of fact. Today, the bonds yield much the same as an equivalent secured bond from a relatively risky provider. If that’s what you want (6.5%), then by all means stay in. But as for me, it’s a fond farewell to this one.
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