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Why “Locking In Your Profit” Is Not a Smart Reason to Sell Your Shares

I’ve been investing for over a decade now and I’ve made many mistakes along the way.

While making mistakes is a common thing in investing (investing legend Peter Lynch once said that even the best in the business can only get six out of 10 decisions right), there’s one error I made a few years back which still haunts me today – the mistake of selling one of my favourite investments because I wanted to “lock in my profits.”

The investment in question is shares of MyEG Services Bhd, a Malaysia-based company that is helping many government departments move their processes online. I first spotted the company back in 2012 and invested in it when I found that it required low capital investments (it was adept at generating free cash flows), produced strong returns on equity, and was growing very fast.

But, after doubling my investment in roughly a year or so, I decided to sell my shares because of my one-size-fits-all investment approach at that time – and that was a mistake.

MyEG’s business continued growing strongly after I sold (for some perspective, the firm’s profits nearly doubled between the fiscal years ended 30 June 2012 and 30 June 2014) and its shares more than doubled from RM1.30 at end-2013 to RM2.70 today.

Cigar-butts and fast-growers: A world of difference

I had learnt about investing mainly from reading books and one of the investment authors who really influenced me was Benjamin Graham. He was a highly successful investor himself and was well-known for the concept of “cigar butt” investing.

Cigar butt investing, an approach I found very useful and is even today a very important aspect of how I invest, involves looking at companies that are unloved by the market and hence have very cheap valuations. The thing with cigar butt-type of companies is that their low valuations are often a function of them having very low-quality businesses.

That lack of quality would mean that these businesses can’t grow much in the future and this in turn gives us no reason to hold on to cigar butts for too long once their share prices have reached our valuation targets.  So, with cigar butt investing, it’s often the case where we’d have to buy a cheap company, wait for its shares to move up to our valuation targets, then sell its shares and then repeat the process with a new cigar butt.

However, the logic of selling a company simply due to valuation concerns may not be a good course of action when it comes to a well-run, high quality, fast-growing company.

With fast-growers with a long runaway to expand, their share prices would reflect the rapidly-growing value of their underlying businesses over the long term (provided of course that their shares weren’t too ridiculously overpriced to begin with).

If you have sold out of such a company at a time even when you feel that its valuation is high, the company’s future growth and compounding of its value may mean that you might never be able to buy back your shares at a similar or lower price point at which you had sold.

Of course, the stock market is a volatile beast and even the shares of the best-run businesses are susceptible to large short-term declines. But even if your fast-growing company sees its shares get beaten down, it is still not a bad situation to be in even if you’re seeing red in your investment. For a company that you’re confident of over the long-term, the shellacking gives you an opportunity to increase your investment at even cheaper prices.

Warren Buffett once commented that “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” The logic here is simple, if the company is of high quality, wouldn’t we be happier to buy it at a much cheaper price?

Foolish Summary

I had missed out on even more gains in what I thought was a quality and fast-growing company because I had invested in it in a similar manner to how I invest in cigar butts. I realize now that this is a mistake and I hope my experience can serve as a lesson for you so that you would not have to make the same blunders as I had.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn't own shares in any company mentioned.