Contributing editor Ryan Irvine is back this week with some thoughts on when (and when not) to sell a security and some updates on previous picks. Ryan is the CEO of KeyStone Financial and one of the country’s top experts in small cap stocks. He lives in the Vancouver area. Here is his report.
Ryan Irvine writes:
When should I sell? This is one of the most frequent questions we hear. My glib (yet truthful!) answer: Never (ideally). I’ll come back to that shortly, but in the meantime, here are five reasons we do sell stocks.
Reason No. 1: Valuation. My company, KeyStone, invests for the long term but sometimes Mr. Market shows a stock too much love. We will consider selling if a stock price has run up to a point where it no longer reflects the underlying value of the business. In some cases, our choice is to sell half our original position in a stock that has had a very strong gain (100% for example) and remove all our original capital if the valuations are simply too rich. The strategy also removes all our initial risk capital and often allows us to continue to hold a great stock and, in the process, sleep very soundly at night.
Reason No. 2: Better opportunities. Sometimes, there’s nothing wrong with a company or its stock. There are simply better opportunities elsewhere that will bring us more bang for our bucks. We will consider selling a less attractive stock (at a profit or loss) if we think we can get a better deal elsewhere. Of course, this analysis is not simple and can be very stock specific.
Reason No. 3: Business changes. There’s no way around it: Businesses change – sometimes significantly. We could be talking about a major acquisition, a change in management, or a shift in the competitive landscape. When this occurs, we incorporate the new information and re-evaluate to see if the reasons we bought the company in the first place still hold true. We will consider selling if:
The company’s ability to crank out consistent profits is crippled or clearly fading.
Management undergoes significant changes or makes a series of questionable decisions.
A new competitive threat emerges or competitors perform better than expected.
We’ll also take into account unfavourable developments in a company’s industry. Here, it’s important to delineate between temporary and permanent changes. In a downturn, financial figures may suffer even for the best-run companies. What’s important is how these businesses take advantage of the effects on their industry to improve their competitive position.
Reason No. 4: Faulty investment thesis. Everyone makes mistakes. Sometimes, you will just plain miss something. You should seriously consider selling if it turns out your rationale for buying the stock was flawed, if your valuation was too optimistic, or if you underestimated the risks. Also, look at selling if the environment has changed, such that your original investment thesis is now flawed.
Reason No. 5: It keeps you up at night. It is tough to put a dollar value on peace of mind, but if we did, it would be a pretty penny. If you have an investment whose fate has become so uncertain that it now causes you to lose sleep, this could be a great cue to move your dollars elsewhere. We are trying to reduce the stress in our life here, not add to it. We save and invest to improve our quality of life, not to develop ulcers. Adding insult to injury, stressing about a stock might cause you to lose focus and make rash decisions elsewhere in your portfolio. Remember, there’s no trophy or prize for taking on risk in investing. Stick with what you’re comfortable with.
While I am loathe to reference “The Gambler” when discussing our investment philosophy, as the concept could not be farther from what we preach, the Kenny Rodgers line “You’ve got to know when to hold ‘em” fits. If there are reasons to fold ‘em, how do we know when to hold ‘em?
Remember, we’re long-term investors, not weak-kneed speculators. It is important to note that not one of these reasons to sell is related to an “analyst” changing a recommendation or simply because a stock has fallen in price. Both provide great fodder for the talking heads of the world but have absolutely no impact on the underlying businesses into which we are buying. Over the course of what will be a prosperous investing career for you, the market will rise and fall. Recessions and booms will happen. And all the while you must stay focused on the long term. Fear is never a reason to sell.
Action: Put it in writing. For each stock in your portfolio, write down why you bought it, your expectations, and what would make you sell. Refer to it frequently – especially before you decide to give a particular stock the heave-ho.
If your original reasons for buying the stock remain intact – the business is growing, management is executing, and valuations remain relatively reasonable – our best advice it to ride out your winners long term.
Real world example
Let’s look at a stock we have held for seven years and never once recommended selling: Boyd Group Income Fund (TSX: BYD.UN, OTC: BFGIF): The shares are up over 2,000% since we first recommended the stock to KeyStone clients and 825% since the first mention in the IWB.
While the stock has performed incredibly well, the company has more than quadrupled its revenue over the past seven years, increased earnings by more than five times, and grown into one of the largest independent auto body repair firms in the U.S.
You only need a couple of stocks like this in your portfolio throughout your entire investment career to make you a successful long-term investor. You just have to know when and how to hold ‘em.
Exco Technologies Limited (TSX:XTC, Financial) (EXCOF, Financial)
Originally recommended on Feb. 27/12 (#21208) at C$4.25, US$4.22. Closed Friday at C$15.58, US$11.77 (Feb. 5).
Exco Technologies was recommended in February 2012 as a buy at $4.25. In our most recent update in the summer of 2014, with the stock trading at the $11.15 level, we reiterated our advice of near-term Hold and long-term Buy for those with an investment time horizon of beyond one year. Today, with the stock trading around $15, we review the company’s fiscal first-quarter 2015 financial results.
Exco Technologies is a global supplier of innovative technologies servicing the die-cast, extrusion, and automotive industries. Through its 18 strategic locations in 10 countries, it employs 5,081 people and services a diverse and broad customer base.
Revenues for the first quarter of fiscal 2015 jumped to $119.9 million from $63.9 million in the same quarter last year – an increase of $56 million, or 88%. The inclusion in the quarter of Automotive Leather Group (ALC), which was acquired by Exco on March 1, 2014, is primarily responsible for the significantly higher sales in the quarter. However, Exco’s existing businesses also grew by 22%.
Consolidated net income for the quarter was $9.6 million ($0.23 a share, fully diluted) compared to $6.7 million ($0.16 per share) in the same quarter last year – an increase of 43%.
Conclusion: Overall, we were very pleased with Exco’s results, which beat expectations on both a revenue and adjusted earnings basis. Given the strong results and solid balance sheet, Exco announced a 20% increase in its quarterly dividend to $0.06 per share, which will be paid on March 27 to shareholders of record on March 13.
Fundamentally, Exco now trades with a price-to-earnings multiple of 17.45 based on its last 12 months, with the stock up over 260% (not including dividends) since our original recommendation. Given the strong start to 2015, we expect Exco is positioned to earn close to $1 per share on an adjusted earnings basis this year, giving it a more attractive forward looking earnings multiple of 15.
Action now: As the company now trades at an equivalent market p/e to the automotive peer group in Canada, we maintain our near-term Hold guidance on the stock. We remain decidedly positive on the company mid-term and maintain our long-term rating at Buy for investors with a greater than one-year time horizon. While the company’s industry is cyclical, we believe the current environment appears positive for the next 18-24 months.
Athabasca Minerals Inc. (TSXV:ABM, Financial)
Originally recommended on Jan. 30/12 (#21204) at $0.485. Closed Friday at $1.04.
Athabasca Minerals Inc. was originally recommended in the IWB in January 2012 at $0.485. The stock surged to the $2.40 range in the early fall of 2012, up over 370%, driven by two sets of record quarterly earnings. At that point, we recommended investors sell half their positions and hold the rest to continue to participate in the solid long-term potential Athabasca possess.
With the stock closing this week a $1.04, we provide an update.
Athabasca Minerals is a resource company involved in the management, exploration, and development of aggregate and silica sand projects. These activities include contract work, aggregate pit management, aggregate production and sales from corporate-owned pits, new aggregate development and acquisitions of sand and gravel operations, and development and supply of frac sand for Western Canada.
On Feb. 12, the company announced the completion of a Preliminary Economic Assessment (PEA), effective date Nov. 26, 2014, for its Firebag Silica Sand Project located approximately 95 kilometres north of Fort McMurray, Alberta.
The PEA shows that the Firebag Project has considerable potential for development as a frac sand resource, which includes the potential for a large, highly economical deposit with high margin, rapid payback, and 25 years of open pit mining. The initial capital costs are $87.8 million. For the life of the project, gross revenue of $3.8 billion is projected and pre-tax operating cash flow of $1.3 billion. Payback period is estimated to be 1.6 years before income tax and 1.9 years after tax.
The PEA numbers look attractive and management has stated the Firebag Project is on target to be in production by 2016. There are plenty of hurdles ahead of this date, including raising substantial, but not unrealistic, amounts of capital.
Action now: Hold your remaining position during this tumultuous time in the Alberta oil segment. We believe the project has good long-term prospects, but it is not without risks in the current climate.
Enghouse Systems Limited (TSX: ESL) (EGHSF, Financial)
Originally recommended on March 7/11 (#21109) at C$9.10. Closed Friday at C$45.17, US$36.
Enghouse Systems was introduced to the IWB in our February 2011 installment when the stock traded at $9.10. In June 2014, with the stock closing at $35.21, we maintained our near and long-term ratings on the stock at Hold.
Enghouse is a leading global provider of enterprise software solutions, serving a variety of distinct vertical markets. Its strategy is to build a larger and more diverse software company through strategic acquisitions and profitable growth.
On Dec. 18, the company reported that its revenue increased by 22% to $220 million for the 2014 fiscal year, compared to revenue of $179.9 million in the previous fiscal year. That resulted in another record year for the company. Income from operating activities was $52.1 million compared to $40.7 million the previous year, an increase of 28%. Net income was $29.7 million ($1.11 per share, fully diluted) compared to $24.3 million ($0.92 per share) in the prior year. Adjusted EBITDA was $56 million ($2.09 per share) compared to $44.9 million ($1.69 per share) last year, an increase of 24%.
Enghouse closed the year with $84.9 million in cash, cash equivalents, and short-term investments, after the payment of approximately $45 million related to acquisitions and $9.4 million to dividends. The company generated cash flows from operating activities of $47.6 million in the year compared to $32.4 million in 2013, an increase of 47%.
The company completed five acquisitions during the fiscal year, expanded the scale and product portfolio of its Asset Management Group, entered new geographic regions, and strengthened its presence in key markets. Enghouse generated strong cash flows and has a healthy balance sheet with no debt. Enghouse remains committed to seeking accretive acquisitions to continue to grow its market share and increase shareholder value.
Having said all this, Enghouse is no longer a secret in Canadian markets. The stock trades at premium valuations as a result of its excellent long-term track record of growth. We believe the company is fairly valued at present, trading at around 18 times adjusted EBITDA, cash out. The company’s cash is held in Canadian dollars. The drop in the Canadian dollar versus the U.S. dollar has impacted the size of the Enghouse’s acquisition war chest as acquisitions are most often completed in U.S. dollars. The decline is offset somewhat by the fact that the company does operate primarily in U.S. dollars.
Action now: We reiterate our Hold rating on a valuation basis. We expect Enghouse will continue to outperform the market long-term.
