When to sell your top performer

The most difficult decision in investing is when to sell. This month I agonised about ejecting the Share Sleuth portfolio's biggest winner.

The most difficult decision in investing is when to sell. This month I agonised about ejecting the Share Sleuth portfolio's biggest winner.

Dart is partly a logistics company, transporting produce from ports and growing regions in the UK to supermarkets. Mainly it’s a budget airline, jet2.com, transporting people from less popular northern airports to sunny Mediterranean resorts. Increasingly, it’s a package holiday company, in the shape of fast-growing jet2holidays.

I added £1,000 worth of its shares to the portfolio in September 2009. Despite dire economic prospects it didn’t take much faith in Dart to buy the shares; the company operated two profitable businesses and a third promising one. It looked cheap even if growth was a distant prospect.

The holiday businesses have done well and the logistics business is still solid. Although the company has paid dividends throughout, the explosion in the share price has rendered them almost irrelevant in terms of total return.

Because of the share price rises, Dart’s earnings yield has fallen to about 8 per cent. In the current climate, that’s a reasonable return, if you can be confident you’ll get it; but I’m not, a fact some shareholders couldn’t comprehend when I shared my thoughts on the Interactive Investor Share Sleuth blog.

They see a company that has grown rapidly, and that, based on tickets it has already sold, will grow impressively this year too. They see a company that is well-managed by an executive chairman who has most to gain from the long-term prosperity of his company because he owns more shares than any other shareholder. They see a company with impressive amounts of cash in the bank, and virtually no debt.

I see those things too. But I’m also nervous. I’m nervous about other budget airlines that, seeing Dart’s niche, might move into it. I’m nervous that as Dart’s dependence on leisure travellers grows, it will find it increasingly difficult to come up with uses for its planes in the winter. I’m nervous about assuming continued growth in an industry that is both competitive and cyclical.

Most of all I’m nervous about my own calculations. I use enterprise value, rather than a company’s market capitalisation, to judge a company’s market value, because it puts companies on an equal footing. If you were to buy all the shares – a whole company – you’d add the debt you would assume and deduct the cash you would receive to calculate the purchase price, which is what enterprise value simulates.

But the financial statements of airlines are different from many other companies. Dart is financed primarily by passengers, who pay in advance for tickets, giving it a huge cash balance, and also by landlords and lessors, who rent it warehouses and hangars and a few of its planes. The cash is recorded on the company’s balance sheet, but it cannot be treated as though it belongs to shareholders because the company needs it to fund the flights, as collateral for credit card companies, and because the Civil Aviation Authority requires it to keep a reserve. In common with other companies, Dart’s lease obligations are not recorded on the balance sheet, but I think they should be.

Deducting less cash and adding more debt pushes the company’s enterprise value (or price) higher, which is why my earnings yield of 8 per cent is much less attractive than it would be if it were calculated conventionally. I adjust the figures using estimates of the right amount of cash and debt, so the valuation is not only higher but even less certain than usual.

I think Dart is a good business, but the valuation is hazy and anticipates growth I would not take for granted. I don’t want speculative holdings to be the largest in the portfolio, so in September I liquidated £2,680 worth of shares, leaving a holding of £1,600, one thirtieth of the portfolio’s total value, remaining.

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