This is an excerpt from Cabot Growth Investor June 21, 2017
Some stocks in the Model Portfolio and others we’ve recommended have had great runs during 2017 but have come under pressure recently. And that’s naturally led to a lot of questions about how exactly to handle big winners, so that’s what we’ll dive into today.
First off, there’s no one perfect way to handle big winners; if there was, then nobody would ever get shaken out and everyone would sell at the top. That’s not going to happen! But keeping three facts in mind will help.
Fact #1: As a growth investor, grabbing a few big winners is key to your long-term success. That’s because it’s difficult to make much upside progress if you’re taking only 15% or 20% profits; those singles eventually get eaten away by small losses (and the occasional loser that gets away from you on, say, an earnings gap). Growth investing tends to be skewed, with a lot of your net profit coming from a relatively few trades.
Fact #2 is that even the best winners are going to have a bunch of scary corrections and tedious sideways periods during their advances. You can use almost any example, but look at Baidu, which we bought in July 2009 and rode for more than two years. Our total profit was 283%, but during its upmove, BIDU had seven pullbacks of at least 14% (see chart). In other words, you’re going to have to take plenty of heat at times.
Fact #3 is that big moves take time to play out. For a stock to run 100%, 200% or more, it’s going to take many months if not longer as institutional investors build positions.
Combining all three, we believe that (a) when you catch a tiger by the tail, you want to try to get as much as you can out of it, but (b) you must use a system that gives you conviction and gives the stock room to correct and consolidate along its way higher while also (c) having an idea of where the stock is within its longer-term advance.
That’s why we advise using our “tight-to-loose” system, which means we start out with a relatively tight loss limit but then gradually loosen our mental stop as the stock advances. Ideally, if we have a big enough profit, we like to simply ride the stock’s 200-day moving average, which usually contains most big winners’ major upmoves. We also frequently (though not always) take partial profits on the way up, which not only books some profit but allows us more conviction in giving our remaining shares more rope.
On the flip side, there are a couple of things we don’t advise. One is to sell all your shares on the way up. We like booking profits as much as anyone, but telling a stock it can’t go any higher can prove very painful if you really do have a true market leader.
We’d also be careful selling a winner with the goal of buying it back later. Such a consolidation might not come for a while, and even if it does, buy points are not always clean-cut. We’ve often seen investors sell out entirely, and then suffer two or three losing trades when trying to re-enter, and then move on … often just before the stock resumes its longer-term uptrend.
Let’s apply these various do’s and don’ts to Shopify (SHOP), our biggest winner in the Model Portfolio this year. The stock has only been advancing for five months—in most cases, big market leaders won’t top permanently after such a short period. So far, we’ve taken one-third of our initial position off the table in late March (way too early in retrospect, providing another lesson of how hard it is to time exits correctly).
We could take off a few more shares if the stock or the overall market turn ugly, but overall, we’re going to try to play SHOP out for a longer-term gain. Currently, the 40-week line is just below 60; we’re unlikely to give the stock that much room. But the 30-week moving average is in the mid-60s and rising quickly, which could provide nice longer-term support should the stock build a deeper consolidation.
Of course, if SHOP fell from here and stopped us out in the mid- to upper 60s, that wouldn’t be great (to say the least). But our experience tells us that giving this type of situation plenty of room usually allows us to sit through a normal correction and benefit from the stock’s longer-term uptrend. And that’s where the big money is earned.