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Every week, Kyle Caldwell and guests take a look at how the biggest stories and emerging trends could affect your investments, with practical tips and ideas to help you navigate your way through. Join the conversation, tell us what you want us to talk about or send us a question to OTM@ii.co.uk. Visit www.ii.co.uk for more investment insight and ideas.
Hello, and welcome to on the money, a weekly look how to get the best out of your savings and investments. In this episode, we're gonna cover the investment dilemma of whether to run a winner or take some profits from an investment that's performed well. And joining me to help tackle this topic is Richard Hunter, head of markets at Interactive Investor. Richard, great talking about Hunter podcast. Right.
Kyle Caldwell:So, Richard, the the idea for this episode came from a listener. We love it when listeners get in touch. And if you've got an idea for a future episode or you've got a question that you'd like myself or one of one of the teams to tackle, then please do email otm@ii.co.uk. So let's now kick off the this week's topic. So I won't read the email in full, but in short, the question is, how can investors decide whether to take profits or run a winner?
Kyle Caldwell:So the person who got in touch said, I've been investing for thirty five years. I'm not a day trader. I normally invest in funds, investment trusts, and ETFs. Some of my holdings are for income and the rest for growth. The trouble that's bugged me since I started investing is when to sell and take profits.
Kyle Caldwell:I don't have problems when to buy. I'm a contrarian I am a contrarian investor, and I like to buy when markets tank or there are dips in the market. I've often read in financial reports that they have sold up and taken profits when a certain investment has done well and then invested the monies in something else. Selling out of an investment when it's doing well is difficult because of the fear of missing out. FOMO.
Kyle Caldwell:So how do the professionals go about this? So, Richard, for me, it's in deciding whether a company share price has reached the limits of its potential or has faded to run. It's an art rather than an exact science. Having said that, what would you say, Richard, how an investor should approach it when they own a company that's performed really well for them? How should they decide whether to run run the winner, take some profits, or sell out entirely?
Richard Hunter:I think we need to go back to square one and and accept the fact that a lot of people think that it's much easier to make a decision to buy a share than to sell it. And if you imagine that you spot a company you might like the look of, you like its prospects, you've looked on your own research, you've looked at some of the metrics surrounding the company and you decide to take the plunge, so you're now in there. After that, of course, you've got money committed to that share. I'll I'll just say share rather than portfolio for simplicity. If the share price goes down, this is when human psychology starts to kick in.
Richard Hunter:Share prices gone down. There's a lot of investors who are reticent to admit defeat, and take the loss even that is the even if that's the right course of action because company's fortunes have changed. If on the other hand, the share price has gone in the correct direction upwards as the investor had hoped, then of course, you do absolutely get that fear of missing out, had it got further to run, etcetera. And I think you've only got to look as far as the amount of market sayings and additives that there are around this very topic to realize just what I'm important and really important. And at the moment also, one of those questions is coming to some investors' mind with a lot of our main market indices on both sides of the pond at or near record highs.
Kyle Caldwell:And in terms of taking a step back, for me, it's examining whether the the current share price justifies the potential future growth. So in terms of valuations, which is, are there any measures you pick out more than others that investors should drill into to ascertain whether a company's looking reasonably valued or has now become overvalued?
Richard Hunter:It's a it's a difficult question in as much as each metric has its own value, and it's normally best to look at a combination of metrics, certainly not one in isolation. In terms of the very word valuation, most people are gonna be thinking about the price earnings ratio and what sort of multiples that share is on, and whether given its share price increase, that's now starting to look a bit frothy. However, it could be that all boats have been lifted in that sector, and on a relative basis, although it's more highly valued than it was, it is an overvalued compared to its peers. Then of course, get other metrics, return on capital, the capital cushion for the banks in particular, the amount of money they're putting aside for any potential global downwinds. There's any number of key metrics that an investor should be bearing in mind before making the plunge in the first place.
Richard Hunter:And at these new higher levels, it's probably worth revisiting why you bought the share in the first place and whether those interests are intact. It's also to consider the wider macroeconomic backdrop as well. Like, for example, we've been in a
Kyle Caldwell:period where interest rates rose from rock bottom levels to peak at 5.25% in The UK. Interest rates are now starting to fall. They're currently 4%. Seeing that as they rose from rock bottom levels to 5.25%, there were certain types of investments and sectors that performed well. And now we're in a different interest rate environment.
Kyle Caldwell:There'll be
Richard Hunter:a new set of winners. Yes. There will. And and just leading on from your example around interest rates, the house builders have had a really rocky time over the last year, eighteen months, mainly because, of course, quite apart from the fact we've got a domestic economy with cloudy prospects, Those higher interest rates have put off a number of first time buyers, new buyers, while house prices have still been on the increase. You can still see that longer term, the house builders have been doing what they can given the fact they're in a very cyclical sector.
Richard Hunter:They've been continuing to buy up land at inverted commerce bargain prices, which obviously they will sell on for a decent margin in due course. But like anything else, they they're gonna kind of step back a bit on building houses if the demand isn't there. And that's quite apart from the fact that in terms of the long term, there's no question that there's a chronic undersupply of houses in The UK. So that's one of the major planks which should remain in place for the house builders. But at this particular moment in time, investors are looking elsewhere for more immediate growth prospects.
Kyle Caldwell:And you touched on the fear of missing out of FOMO. So when a company does well, there can also be a strong emotional attachment to a company. Some investors can potentially fall in love Yeah. With a stock because they they love their returns. They've had, and they're hoping they're gonna get more in the future.
Kyle Caldwell:How can investors detach themselves from this risk? There's a couple of
Richard Hunter:things, quite apart from recommending you don't fall in love with your investments to treat it with the same cold eyes that you did when you bought it. But one of the things we've already mentioned, which is to revisit whether it still fits into your investment strategy, into your growth objectives, and so on. And whether maybe you think that maybe it has run its course and even within the same sector, there's other opportunities coming through and perhaps you can see echoes of company b as compared to company a that you've been invested in. There's a couple of other things as well in in investment jargon, something called top slicing. Let's imagine you bought £10,000 worth of shares and you absolutely got it right and the share price went so high that your investment is now worth £20,000, so you've doubled your money.
Richard Hunter:Top slicing would involve selling £10,000 worth of those shares, so your original investment is covered. You've now broken even. The remaining £10,000, a, leaves you with skill in the game and b, is pure profit. So that's one of the things that you can do. It probably won't be a 100% usually, but on those percentages, you can see the point that top slicing could actually keep you involved.
Richard Hunter:I do often hear that from full managers when I interview them that they top slice stocks. And sometimes it's because they think the valuation has become a bit too rich, but other times, it's because of the fund's mandate. So
Kyle Caldwell:Yeah. The stock has become too larger percentage in the funds relative to the risk level of the funds. That sort of, like, force their hands. So in in some cases, it's not entirely the decision. Well, it is their decision.
Kyle Caldwell:It's the full manager's decision ultimately, but they sort of for, like, a a risk management reason, they also need to sell. Like, for example, some funds invest in a particular area of the market. So some UK funds will invest in UK smaller companies. And if the stock becomes much more successful in share price terms and and and the overall business, then that stock can go from the FTSE small cap index right up into the FTSE one hundred. And an an example of that is that I can think of is Games Workshop.
Kyle Caldwell:And if you run-in a UK smaller company fund mandate, Games Workshop is no longer a UK smaller company share, so they have to sell. Even though I'm sure many of them would like to continue running it as
Richard Hunter:a winner because it's become a more successful and more profitable business. And in some ways, that's a nice problem to have, but there is no reason why you can't also apply that thinking to an individual portfolio. If you've got 10 stocks in your portfolio, 10% in each, one of them really does go off to the races, and it's now worth 20% of the overall value in terms of rebalancing, you might wanna consider getting back to the equal level you had previously.
Kyle Caldwell:And in terms of individual stock positions, it's very rare to see a funds have more than 10% in a single stock. And the reason why is for regulate regulatory reasons in order for this for the for the fund to be sufficiently diversified. So there's a rule called the five ten forty rule. And under this rule, funds can have more than 10% invested in a single company, and holdings that account for 5% each cannot exceed 40% of a fund's assets. However, with investment trusts, they don't have that sort the same sort of rule in place, but in practice, it's very rare to see an investment trust have more than 10% in a single stock, and it's very rare to see it around 15% or higher.
Kyle Caldwell:So for managers and indeed private investors, Richard, they also often have price targets for a stock, and that can help you have discipline. And, obviously, when it hits that price target, then that's that's a sign to then sell. And, also, investors can put stop losses in place in which you automatically sell some of your holding when it reaches a certain level. Could you explain how stock losses suit certain investors? Yeah.
Richard Hunter:It might well be that it's you're a cautious investor. Perhaps it's one of your earlier investments. Let's say you buy the shares at a price of $1.20, and you decide that you you don't wanna take losses with, say, 20 p per share. So you put a stop loss limit on of a pound, and should the shares drop by 20p, they will automatically be sold. That's as opposed to looking at how your investment's getting on six months later.
Richard Hunter:I need to see that it's now halved to to 60 p, and, obviously, you've lost a a good percentage of your of your investment. So it's it's a question really of just putting a level in place which you could comfortably, although painfully, expect to accept.
Kyle Caldwell:And as you've already touched on, Richard, the size the stock becomes in the portfolio is ultimately one most important things that you can consider. You gave that example earlier, say an investment doubles from 10,000 to 20,000 by by top slicing, as you described.
Richard Hunter:That also rebalances your portfolio, and it brings it back down to the level of risk that it was in the first place. Yes. It does. And it's never a bad thing to spring clean your portfolio, because some of the things as you carry on through your investment life are going to change. It may be, for example, that you're a forced seller at some point, either due to personal circumstances why whereby you might have to raise some additional cash or even if you're pending retirement, and it may well be that you're no longer particularly interested in growth stocks, your requirements are now much more based towards income.
Richard Hunter:And so you would sell them sell out of your growth stocks into more stable income stocks. So around the whole question, as with so many types of investment, it's going to tend to vary from individual to individual, Although, hopefully, we've covered some of the overarching themes, which is that knowing when to sell in the middle of the battle has been a conundrum for some considerable time.
Kyle Caldwell:And in terms of funds, investment trusts, ETFs, I'll just provide a couple of pointers for myself regarding whether to run a winner or to take some profits. Before I get to those, I want to mention we previously, on the podcast and done episodes in which we talk through the reasons to sell a fund and how to judge performance. So I'll put a link to that episode in the description of the podcast. So that was more related to if the fund or investment trust wasn't performing well or if the full manager running the funds had left or retired. So they they were the main sort of bits that we covered in that episode, but related to whether it's been a top performing funds, whether to take some profits or keep it as a winner.
Kyle Caldwell:It goes back to the points that we've made for individual companies. It goes back to the reason you bought the funds in the first place. Does it still fit into your portfolio? Does it still fit into your objectives? And then also consider the wider backdrop.
Kyle Caldwell:Has the reason why the funds performed well over the over short or medium term time frame, has that been down to its investment style? Has it done well because the macroeconomic conditions have been in the fund's favor? Particularly, think about that regarding more adventurous funds, such as, say, a fund that invests solely in India or solely in China. Has it been a a strong backdrop for either of those stock markets? Because over time, it does ebb and flow, and specialist funds, they can go in and out of form pretty quickly.
Kyle Caldwell:So, you know, ideally, you wanna invest for the long term of, you know, at least five years, ideally ten years or more. But if it has been a strong period of performance, I question why, and I I would consider potentially taking some profits because, you know, it's it's not gonna be a strong run of short term outperformance forever for a particular market. And with investment trusts, one thing to watch out for is whether an investment trust trades on a premium or a discount. If you see an investment trust that's trading on a premium of more than 5%, certainly more than 10%, I would consider waiting until that premium cools because over time, history has shown us that investment trust premiums, they don't sustain over the very long term because conditions change. And when conditions change, those premiums tend to arose.
Kyle Caldwell:One example of that is when interest rates were at rock bottom levels. So for around four years ago, there was a lot of demand for renewable energy infrastructure investment trusts. Think at the 2021, the average renewable energy infrastructure investment trust was trading on a premium of around seven or 8%. Today, the whole sector's on, like, a a discounted over 20% on average, and that's because the the environment's changed. It was you know, people were seeking out these investment trusts that were offering a good level of inflation being income when interest rates were rock bottom levels.
Kyle Caldwell:Today, they're still offering that, or investors can get, you know, a decent level of income from bonds and also money market funds, and that's reduced the appeal for those alternative income areas like renewable energy infrastructure. So that's all we've got time for for today. My thanks to Richard, and thank you for listening to this episode of On the Money. And if you enjoy either, please follow the show in your podcast app. And if you get a chance, leave us a review or a rating in your podcast app too.
Kyle Caldwell:We'd love to hear from you. You can get in touch by emailing ocm@ii.co.uk. And in the meantime, you can find more information and practical pointers on how to get the most out of your investments on the Interactive Investor website at ii.co.uk. And I'll see you next week on your preferred podcast app or on Vizio on YouTube. See you then.