Cut losses and run profits

During the period February 1993 to mid-December 1993, I have recommended a total of 14 shares in this column. I cannot describe them as a portfolio because for many important months there were only two to three investments, although I was in a very bullish frame of mind at the time.

Indeed, in March 1993 I wrote about the case for a continuing bull market and only began to change my tune in January of this year.

I usually recommend 10 shareholdings in a portfolio, so it would be reasonable to look upon 10 per cent as the average unit.

Three of my recommendations were for a China pot totalling about 15 per cent of a portfolio. I have therefore treated the three Hong Kong shares as one unit of 10 per cent.

You will remember that I have frequently explained that it is necessary to run profits and cut losses. I have also suggested cutting losses or taking profits on the shares I recommend, if they fall to 25 per cent below the highest price reached after purchase.

I have also recommended selling immediately if there is major adverse news and the story changes very much for the worse.

Losses were cut at an early stage on Micro Focus (25 per cent), Sage (25 per cent) and Tepnel Diagnostics (15 per cent).

My experience with the first two has encouraged me to cut computer software companies out of my future selection process. I made an error with Tepnel in departing from my usual system and straying into biotech. I took a small profit (12 per cent) on Shoprite when Sainsburys made noises about a price war. This turned out to be a mistake as Shoprite continued to do well and looks well set for the future.

Shares should also have been sold automatically in British Data Management at 202p, when it was 25 per cent below the high of 269p, and in Ingham at 123p, 25 per cent below the high of 164p.

Hong Kong profits would have been taken on Innovative International and S Megga on a similar formula. The overall result from these four transactions showed a small profit.

The remaining Hong Kong share, Yue Yuen, is teetering on the brink of being cut as its high was HKdollars 2.45 and it is currently dollars 1.90. The prospective p/e ratio is 6.5, the growth rate 17 per cent and the dividend yield 6.5 per cent, but if the share price continues to decline, I would stick to the formula and cut the position.

This brings me to the better news of the shares that have made most of the running (see table).

As you can readily see, Flextech, Essex Furniture and Amersham International are the star performers. Flextech was sold when it reached 358p because that was 25 per cent below its high of 478p.

When they were purchased, it was very much a case of Flexwho?; now with TCI's acquisition of control and the boom in multimedia stocks, everyone knows the story of Flextech.

Amersham International, in life science research, continues to perform well with growth in earnings per share for the year ended March 1994 expected to be almost 50 per cent. The following year a further 20 per cent growth is forecast, bringing the future multiple down under 20.

Essex Furniture, the manufacturer and retailer of home furnishings, remains one of my favourite growth stocks. The consensus forecast for growth in earnings per share for the year ending June 1994 is 47 per cent and 42 per cent for the following year. The 1994/5 multiple is about 19, but I believe that all of the forecasts will be handsomely beaten and the shares remain a great buy.

Motorworld looks good value with a 1994/5 multiple of about 12. This retailer of car parts and accessories has a formula that can be cloned, and growth should continue at about 15 per cent per annum.

Electron House, a supplier of electronic components, remains a hold. Earnings per share should be up 50 per cent in the year ending May 1994 and about 35 per cent next year, bringing the forward multiple down to a relatively attractive 14.

Total gains on pounds 1,000 invested in each of my UK recommendations and pounds 333 in each of the three Hong Kong shares, come to pounds 2,520 based on my recommendation prices, and pounds 1,906 on the prices at the close on the day of my recommendations. This compares with a gain of pounds 1,192 on an equivalent investment in the FTA All-Share index during the same holding periods.

Some of the shares were only held for a few months, so it is most representative to take the average number of 10 per cent units invested during the period. This was 6.625, which is equivalent to an investment of pounds 6,625, based on which the capital appreciation has been 38 per cent over my recommendation prices, against a gain of 18 per cent in the FTA All- Share index on a comparable basis.

With many of my recommendations, patient readers would have been able to deal at a small premium to the recommendation price. However, even taking the harsh measure of closing prices on the day of recommendation, the capital gain would still be 28.8 per cent.

I was disappointed that my recommendations included a higher number of loss- makers than usual, which did, of course, affect the average performance. However, the advantage of running profits and cutting losses is clearly demonstrated by the overall results.

Cutting losses and running profits is the single most important investment rule, and psychologically the most difficult one to follow in practice. It is much more tempting to snatch profits before they disappear and hang on to loss-making shares, hoping that they will recover. In my experience, this is not the way to make money in the stock market.

The author is an active investor who may hold any shares he recommends in this column. Shares can go down as well as up. Mr Slater has agreed not to deal in a share within six weeks before and after any mention in this column.

----------------------------------------------------------------- SHARES THAT MADE THE RUNNING ----------------------------------------------------------------- Recommended Present % gain price price Flextech 154p 358p* 132 Amersham Int'l 695p 1050p 51 Essex Furniture 150p 248p 65 Motorworld 257p 304p 18 Electron House 118p 142p 19 *disposal price -----------------------------------------------------------------