Why Taking Profits Is Never Overrated

by: Bill Maurer

I get a lot of questions on the stocks I cover. Most of them are very similar, and it was a recent e-mail that got me thinking for this article. I won't say which stock the reader asked about because I'll be covering it plenty in a little while. But the theme is always the same. No matter what the situation is, never be afraid to take a profit in a stock you have gains in. Because just as quickly as you have a profit, you can lose it, and your gain can become a loss. I've had it happen to me plenty of times, especially after plenty of debating about when the proper time was to sell.

So what spurred this article's creation? Well, a reader e-mailed me recently asking about Apple (AAPL). I don't remember the exact wording, but it was something like this. I followed your advice on Apple, getting in below $400. Now that we are at $600, do I hold onto it through earnings or sell before?

The reader was talking about my recommendation from last September and October, where I advised getting into Apple under $375. There were several chances to do so. Then Apple ran up into earnings, where it missed expectations. That caused the stock to drop, and I again advised getting into Apple on the drop, under $400 if you could, but definitely under $375.

Now Apple has had a huge run since then, and we are currently just under $600. Yes, in a few weeks, Apple will be reporting earnings, and it is likely to have a huge impact on the stock. We could see the start of the next leg up, possibly to $700, or we could see the first big decline in the name in several weeks, perhaps falling back to $550 or perhaps lower if the report is truly bad. I don't really see a bad report, but hey, anything is possible.

Now, there is nothing wrong with taking profits. Let's say you bought Apple at $400. At $600, you could sell for a 50% profit, which amounts to $200. Even if you factor in capital gains taxes or commissions (if you have them), it is still a nice profit. Even if you have only one share of the stock, you have made enough of a profit to take an average family of four to a baseball game. Now sure, you won't exactly be sitting right behind the Yankees dugout, but the "average" family just wants to be at the game. It is all about the experience. Now, if you hold a number of Apple shares, you might be able to afford those seats by the dugout. Either way, if you bought Apple at $400, you are sitting pretty, and there is nothing wrong with taking a profit.

So let's say you take that profit. Congrats, you have now booked a nice chunk of change. If the stock goes higher, you are going to regret selling, sure, but you've got that $200 or so in your pocket. If the stock drops, you could only have $175, or $150, or whatever. You should feel great that you took the profit, and not worry if it goes higher. Besides, if you take a profit, you can buy the stock back at any point. Say Apple rises to $605, and you want to get back in. You can get right back in.

You missed $5 of the rally, but you've booked a $200 profit, and weren't willing to risk your gains for just $5 more. You could easily lose on this new trade, but this is a new trade. Don't worry about the last one. The more time you spend thinking about a trade that has been completed, the worse your future thinking will be. Trust me. Get any regrets out of your system as soon as possible. They will only build up over time.

Now let's examine the other possibility. Apple falls after earnings, and for this argument, let's say it drops to $550. If you sold your position at $600 and recorded that gain, you now feel great. You can buy back the stock even lower. If you didn't sell, 25% of your gain is now gone, and you'll have even more regret that you lost profits than if you didn't book even more gains. Again, don't let regrets build up.

So what else can you do with your position? Well, you could always sell it, and move some of the money into options. For this example, assume you have 100 shares of Apple that you again bought at $400. You are up $200 per share, or $20,000 total. You could sell that stock, record the gain, and if you have the ability to trade options, buy a deep in the money call. What is the advantage of this? Well, let's say you buy a July expiration $500 call. This will cost you a little more than $11,000 currently per call, which is much less than the $60,000 it would take to buy 100 actual shares. You pay a premium, about $11 per contract, so $1,100 in total, but you essentially are long 100 shares.

Because this call is deep in the money, it generally will track Apple shares at a similar ratio. That means that if Apple jumps $5, the call will jump approximately that. If Apple shares continue to rally, you make the same profit, but with a lot less dollar risk up front. Instead of having $60,000 involved in the trade, you only have $11,000 to start. The other $49,000 is now in your pocket.

I have been getting similar questions on a few other names, so I will focus on them as well, involving the similar strategy of taking profits. The first one involves Deckers Outdoor (DECK), the maker of the widely popular UGG brand. When I first started writing about Deckers in mid to late December, I stated that in the low $90s, it was a good short. The name traded down to the mid $70s quickly, where I advised to take profits again (on your short positions), and if you were really interested in a risk, turn around and go long the name. That worked too, and the stock bounced back into the mid $80s. Before the last earnings report, it got back into the low $90s again, and I advised shorting again.

Other than a few minor daily jumps (one of which I took advantage of), Deckers has gone almost straight down, and now trades at just $63. If you shorted the name at $90, or even $85, you might want to think about covering here. Yes, the guidance was bad, but expectations have not come down enough to warrant a $30 drop in the name. The stock is trading at just 10 times next year's earnings, which seems rather cheap when compared to Crocs (CROX) at 12.5 times, or Nike (NKE) which is about 18 times (although Nike's fiscal year ends in May and Deckers and Crocs are calendar years).

Still, the valuation seems fair to cheap, and I really don't see much more downside from here. Yes, it could drop below $60, but if other shorts start to cover, you don't want to lose half of your profit if Deckers gets back to $75. Of course, you could try a similar strategy as I mentioned with Apple, but for Deckers you would sell deep in the money puts. I would advise against it here, just because I don't see that much more downside in the name.

Now onto one of everyone's favorite names, Netflix (NFLX). If you were one of the lucky, or perhaps crazy, ones to buy the name when it bottomed in the low $60s, you doubled your money when it got back to $125 and $130. Even now at $115, you still have made a huge gain. Netflix's rise was in so short a time that you would be crazy to not sell if you had doubled your money. Recently, Netflix fell below $103, so you could have potentially had a $70 gain fall into a $40 one, and that is on a $63 stock. You don't want to lose that big of a gain ever. You just don't. Now, even if you bought Netflix at say $90, you are still up $25. You might consider taking that gain before earnings. Netflix could easily crash.

But what happens if it goes up? Well, when Netflix reported earnings last time, it rose to about $108 after earnings, initially. More buyers came in and short covering took place, so even if you missed the initial pop, there was still another $25 to be had. If you lose part of your profit on Apple, it is one thing. But if you lose it on a stock like Netflix, you only have yourself to blame, and I will definitely tell you I told you so. Trust me, if this name reports a good quarter and has good guidance, it will rise. You might miss the initial pop, but everyone will pile in again, and there will be plenty of money to be made then.

The same is true of Green Mountain Coffee Roasters (GMCR). The high growth name, which traded up to $115 before its epic collapse last year, traded down to below $40. It got back to almost $54 before earnings, where it reported a blowout quarter. It jumped nearly $13 the next day. I took a quick $8 profit, and I was extremely excited about it. If you bought before earnings, you were stupid to not take profits in the name, especially with that huge one day rise. Those that took profits in the high $60s or low $70s look very good.

On March 5th, this name was as high as $69.46. Less than one month later, we are under $47. We are actually now down $7 since the earnings report came out. That is how quickly gains can turn into losses. Don't let it happen to you, especially if you have the ability to pocket huge gains. I took an $8 profit, and that was in just a matter of hours. Anyone who had even more gains should have taken them, and I hope you did.

Finally, I will touch on Sina Corp (SINA), one of the big Chinese internet names. In early January, I advised getting into this name if it fell under $50 (it was in the low to mid $50s at that time). It did, and it turned out to be a great buying opportunity. Sina had a huge run, and made it up to about $70 on news of the Facebook (NASDAQ:FB) IPO. I said to be cautious at these levels, and I would possibly consider shorting the name if it got to $75.

It actually got over $80 at one point, although my money was tied up elsewhere and I didn't get to short it. Still, I advised taking profits. Even with the stock back down to $65 currently, it is still trading at more than 90 times this year's earnings per share, which might seem excessive to some. Imagine what the valuation was at $70 or even higher. If you bought at $50 and didn't sell at $80, you have actually lost half of your gains.

The point of this article was not to say I told you so. It was to remind you that there is never a bad time to take a profit. Yes, you can miss further gains, but would you rather lose half of your gains, as investors in Sina Corp have seen? Or worse, would you rather have lost money, as those in Green Mountain have? Don't be afraid to take profits. If you want to still be in the name, maybe you should only sell half of your position, or try an options strategy like the ones I have mentioned above. Either way, taking profits is never overrated.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL, DECK, GMCR over the next 72 hours.