Wednesday, September 24, 2014

Why periodic profit booking in a bull market is a good idea – a guest post

Most new retail investors join the party late – after a bull market has already been in progress for some time. New highs are hit on a regular basis by market indices and individual stocks. Investors feel excited that the shares they have bought at already high prices are moving even higher.

But stock markets don’t move in only one direction. Corrections in bull markets are common and happen often. Some times these corrections are small – between 3-5% – but once in a while, a 15-20% correction from the top causes panic when some stocks lose more than 30-40% from their tops.

In this month’s guest post, Nishit argues in favour of partial profit booking on a regular basis to turn notional profits into real cash that can be redeployed on corrections or enjoyed as spending money.

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Often the main questions of small investors are when to buy shares and when to book profits. The stock markets are driven by 2 factors - Fear and Greed. Fear grips when markets are falling and that is what prevents investors from buying shares at mouth watering prices. Those who bought shares in August 2013 have seen share prices of very good companies double or treble.

The second emotion which drives investors is Greed. If Aug’13 was driven by Fear we have September’14 driven by greed. When does one book profits? The markets may go up further. We may miss profits if we sell now. Then, one day a crash may come and wash away the entire amount.

So what does the retail investor do in all this?

For every investment, there has to be a price fixed where profit has to be booked. Without booking profits, they remain notional profits. At the same time, there are several investors I know who have been holding a ITC shares since the 1970s and they have become worth crores after splits and bonuses.

Suppose I have bought 200 shares of a company X giving a dividend of Rs 1 at Rs 100. I book partial profits after the shares reach a price of Rs 150 where I get rid of say 30% of my shares.

My original investment was Rs 20000. I have booked profits worth Rs 9000. My cost price for remaining 140 shares becomes Rs 11000 - which is about Rs 78.50 per share. Re 1 dividend on Rs 78.50 gives me a dividend yield of about 1.3%. Over a period of time the company is expected to do well and the dividend amount will increase. At some point, I will get a tax free dividend yield of 5-6% - which means my residual shares have become almost like a bank FD.

Also, if I follow the markets closely I can do a bit of trading in the shares of the same company.

From the freed-up capital, I am able to make fresh purchases, or enjoy the fruits of my investments (if we do not enjoy the fruits then why invest?)

There a few riders to this strategy. The company has to be a very good company like an Axis Bank or Yes Bank or a Voltas.

Business scenarios change and the company’s products or services may become obsolete - so one must be ruthless about dumping the company if it is no longer doing well.

Hence, please book profits regularly, and enjoy the fruits of your hard work.

It is a good time between now and Diwali to take some money off the table if the market continues to rise.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan. You can reach him at nish.stockid@gmail.com)

2 comments:

Khambatta said...

Nishit, I think this does not seem logical, and in fact, the article is contradictory (eg, the example of a stock held since 1970 which would have made crores as of today).

Illogical specially since on a general basis, companies that have increasing dividend increase in price as well (over the long term).

Fruits could be the increasing dividends themselves, as opposed to booking profits from existing investments just to reinvest in new ideas.

There is no joy in investing in fresh ideas, when one can keep invested in the same idea. Some of your best ideas are the ones you are invested in.

If one is so keen on booking profits to reinvest in new ideas, I would suggest booking profits in your mind and reinvesting in the same idea.

Nishit Vadhavkar said...

Hi,

That is one way of looking at it. But what if the stock doesnt make crores? For every HUL we have a company which has fallen by the way side.
My intent is to book profits but at the same time not exit the company.
The dividends may stop coming over a period of time. Idea is reduce my risk to a point where I can live with entire residual capital being lost.
To each each own, this is 1 method which has brought me great rewards as well as peace of mind which I value most in life.