How to Know Exactly When to Sell a Winner

Back in November, I discussed the two crucial questions you should ask yourself about any winning position.

Since then, the market has pulled back more than 7%. Some of the big winners in your portfolio may not be performing well lately.

You might be thinking it’s time to lock in profits – after all, some profit is better than no profit.

[ad#Google Adsense 336×280-IA]But as I’ll show you today, it’s important to act rationally and logically and not to let your emotions get the best of you.

In that essay, I shared the story of the most successful recommendation in Extreme Value’s 13-year history: giant wine producer and beer importer Constellation Brands (STZ).

Constellation Brands is a World Dominator when it comes to alcohol.

It’s the third-largest beer supplier in the U.S., with brands like Corona and Modelo.

It’s also responsible for top-selling wine brands like Robert Mondavi and spirits brands like Svedka vodka.

Last month, Constellation reported results for its fiscal third quarter ending November 30, 2015. The results were excellent, and management increased its outlook for full-year earnings and free cash flow.

In addition to being the world’s leading producer of premium wines, Constellation owns the exclusive right to import, market, and sell six Mexican beer brands in the U.S., including the No. 1 imported regular beer (Corona Extra), the No. 1 imported light beer (Corona Light), and the No. 2 imported regular beer (Modelo Especial).

The wine business is doing well. The beer business is booming.

Net beer sales for the first nine months of fiscal 2016 grew 11%. Management now expects full-year growth to be 12%-14%.

To accommodate growing demand for its portfolio of Mexican beers, Constellation announced an additional 2.5-million-hectoliter expansion of its main brewery in Nava, Mexico, as part of its third-quarter report (1 hectoliter = 26.42 gallons).

When complete in 2018, the Nava brewery will expand to 27.5 million hectoliters – almost three times larger than when Constellation acquired it in 2013. The company also announced plans for another 10-million-hectoliter brewery closer to California in Mexicali, Mexico.

Provided that future demand growth meets management’s lofty expectations, these capacity additions will enable Constellation to continue growing revenue and profits at strong rates. Rising revenue and profitability, should they materialize, are also likely to keep pushing the stock price higher.

As of yesterday’s close, we’re sitting on a 623% gain on Constellation in our Extreme Value portfolio. When a stock becomes a big winner like Constellation has, fighting your emotions becomes a big challenge.

If the stock suddenly starts declining, your emotions tell you to sell and lock in profits. If it starts surging, you wonder if you should sell amidst the sudden euphoria, particularly if the broader market has been on an extended, multiyear run.

Don’t give in to temptation or act irrationally. Avoid prematurely closing a big winner by asking yourself these two questions:

1. Is the original investment idea still valid?
2. Have the shares become fully valued?

Constellation’s growth and profitability have exceeded the expectations we set back in 2011. There are currently no indications that the business will stop performing well. The original investment thesis is still valid.

At a recent price of around $150 per share, STZ is valued around 25 times our estimate of 2017 stabilized free cash flow. That’s not cheap enough to recommend buying STZ shares. It’s now approaching our estimate of intrinsic value – about 30 times free cash flow.

Shares are not fully valued, but they’re getting close. We’ll continue to watch this one closely.

In sum, once you have a big winner, don’t put it on autopilot. Regularly ask yourself if the reason you bought it is still valid and if the shares are fully valued.

Asking these questions will take emotion out of the decision-making process as much as possible and help you avoid selling a big winner prematurely.

Good investing,

Mike Barrett


Source: Daily Wealth