With equity markets topping new highs, the resulting profits have retail and institutional investors alike wondering whether it’s time to cash in.Getty Images/iStockphoto
If making a profit by buying stocks boils down to gut instinct, making a profit by selling them is an art.
If you had the gut instinct to buy a diversified basket of stocks in the depths of the 2009 global financial meltdown, your portfolio has more than tripled in value.
But with equity markets topping new highs, those profits have retail and institutional investors alike wondering whether it's time to cash in.
"You always have to revisit your thesis: why you bought it in the first place, what you expect to happen and do you have better places for the money?" says Barry Schwartz, chief investment officer and portfolio manager at Toronto-based Baskin Wealth Management. "You shouldn't just sell a stock because it has gone up in value. That's just stupid."
For Mr. Schwartz, a stock's true value is relative to the company's earnings. If past or potential earnings keep pace with the price of the stock, he says the sky is the limit. If the price of the stock outpaces earnings growth, it's time to sell.
"I don't let the market dictate what I'm going to do. I let valuation tell me what to do," he says.
Mr. Schwartz uses the big Canadian banks as an example of stocks that live up to their value. Shares in all five – the Bank of Montreal, Toronto-Dominion Bank, Bank of Nova Scotia, Royal Bank of Canada and Canadian Imperial Bank of Commerce – have more than tripled since the 2009 low, but their prices have sustained price-to-earnings multiples in the teens. "If you've got a rocket ship, getting off too early is a big mistake," he says.
His one exception to the rule relates to portfolio diversification. As a stock outgrows other stocks it can hold too much sway in the performance of the overall portfolio, and he says it could be time to rebalance by trimming some of your profits.
"You never want to let anything become more than 10 per cent of your portfolio unless you know it intimately well," he says.
Mr. Schwartz also says investors should hold off rebalancing unless they know where they are going to reinvest those profits, and keeping it in cash waiting for a market pullback is a bad idea.
"Sitting on cash is one of the dumbest things investors can do," he says. "You can't watch the market 24/7. Most corrections are over faster than you know it, and once it happens you're going to have analysis-paralysis anyway," he says.
Lorne Steinberg, president of Montreal-based Lorne Steinberg Wealth Management, disagrees. He's been trimming profits in his equity fund and bulking up his cash position to 30 per cent.
"The stock market has been rising a lot faster than corporate earnings. That's not sustainable forever," he says. "In this environment, it is prudent that as the market goes up you increase your cash position."
The entire benchmark S&P 500 has grown beyond its fundamentals, he says, currently trading at 22 times earnings compared with its historic average of 16 times. As interest rates rise, some of the "frothier" sectors that usually pay generous dividends such as consumer staples, pipelines and utilities are coming under pressure.
"If these asset classes did well because interest rates went down, it begs the question: What happens when interest rates start to go up?" he says.
Mr. Steinberg looks at cash as a form of cheap option that gains in relative value when markets fall. "I'm waiting for the opportunity to buy more cheap stocks," he says.
Even if broader markets continue rising, he says cash can come in handy for individual opportunities in weak sectors such as retail. "We look for great businesses, which are strong financially, and have a stumble," he says.
"I don't fear a valuation crisis," says Bruce Murray, chief executive officer and chief investment officer at Toronto-based Murray Wealth Group. He's quite comfortable with markets in record territory, and he goes back to the last century to find a comparison in what is termed the Nifty Fifty – a group of blue-chip stocks that outperformed the market with multiples well above 40 times earnings during the last sustained period of low interest rates, between 1930 and 1970.
His firm is "still not afraid of stocks in companies leading the economic transition, like Google, Facebook, Amazon and MasterCard, which comprise about 18 per cent of our global growth portfolios," he says. "Global economies are strong, and the shift to electronic commerce still has a long way to go both generationally and geographically."
The Nifty Fifty party ended in 1972 with the Arab oil embargo and inflation that followed, but Mr. Murray says investors can still find opportunities now. "We're still finding stocks that we can buy, so when other stocks hit our target prices we sell them and switch into other stocks."
One thing Mr. Murray does not do when he sells a stock is to keep the money in cash. He says there are far better options: "Why would I hold cash when I can find somebody who will pay me a 3- or 4-per-cent dividend yield that will grow?"