One of the conundrums all investors face is when to bank profits on a winning shareholding. Clearly, a company’s valuation should be the ultimate trigger point, which is why I always ask myself whether or not I would be comfortable investing fresh capital into the shares even at the higher price.
If the answer is no, then I ask myself whether or not my fair value target price could be too conservative. That’s because other market participants may take a different viewpoint on a company’s true worth, and if enough of them think this way then the weight of their money will dictate the direction of travel. Human psychology plays a major part in the decision-making process, too, as the risk of not running profits could lead to you missing out on making even healthier gains in the future.
One way of getting round this problem is to adopt an investment strategy known as top-slicing – the process of selling part, but not all, of a holding. By taking this approach you are maintaining a financial interest while at the same time mitigating the risk of your paper gains being eroded if investor sentiment turns. A good example of how this works in practice is my share recommendation on Trifast (TRI:193p), a small-cap manufacturer and distributor of industrial fastenings, with operations across 31 locations across the UK, Europe, Asia and North America.
I first advised buying the shares, at 51.9p, in my 2013 Bargain Shares Portfolio, and by the time I first suggested top-slicing half the holding two years ago the share price had soared to 223p ('Hitting target prices', 2 May 2017). I then recommended doing exactly the same thing again when my 275p long-term target was hit in April 2018 (‘Five small-caps with Character’, 30 Apr 2018).
I am glad I did because Trifast’s share price subsequently lost a third of its value and had retreated to 193p when I last recommended running profits earlier this year (‘On the engineering beat’, 18 Feb 2019), a stance that was predicated on the likelihood of a sharp V-shaped bounce in global equity markets from their fourth-quarter lows and one that I predicted a month earlier ('Profit from unwinding of recessionary risk', 21 Jan 2019).
In the event, Trifast’s share price rallied and hit a high of 240p in May before profit-taking took hold. The subsequent pullback to the 193p level came about after the directors cautiously noted at last week’s annual meeting that: “There can be no doubt that the macroeconomic environment has become more volatile over the last 12 months and the associated uncertainty has manifested in lead times on production schedules moving out on a number of new business wins. This has impacted the start to 2019/20 financial year, also marked by some instances of subdued demand in certain specific geographies as well as the ongoing automotive slowdown.”
Although the board reported a solid pipeline and encouraging activity levels, and analysts are maintaining forecasts that point towards Trifast delivering flat earnings per share (EPS) of 14.5p in the 12 months to 31 March 2020, investors have become more cautious which is why the shares now trade on a price/earnings ratio of 13.3. That’s a fair rating, but not one that offers much in the way of upside in light of the macroeconomic outlook.
In the circumstances, I feel that it’s time to bank the balance of profits from a holding that has generated truly eye-watering returns. For example, a £10,000 investment in Trifast shares has already realised £36,750 from the two earlier disposals (including dividends) and will be boosted by a further £10,000 by closing out the investment. Take profits.
■ Simon Thompson's new book Successful Stock Picking Strategies and his second book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £2.95, or £3.75 if you purchase both books. Details of the content of both books can be viewed on www.ypdbooks.com.
