Over the last couple of years I have at various times, including here and here, written articles that were extremely bullish on the mobile payments company Square (SQ). Since that first piece in August of 2016, SQ is up nearly four hundred percent. I am in danger of pulling a muscle from reaching around to pat myself on the back on that one, but now is finally the time to take a profit on the stock.
When to do that is one of the most difficult things for retail traders and investors to decide. When is enough enough? Having spent nearly twenty years making a living in dealing rooms around the world I can assure you that when to cut a winner is not just a problem for amateurs; it can be just as difficult for pros.
Nobody wants to take a small profit once momentum is established, but anybody who has seen a good profit turn into a loss knows that momentum can shift rapidly, often for unforeseeable reasons or even for seemingly no reason at all.
The longer a stock runs in your direction, the harder it becomes to ever take a profit. Over time, stocks in general trend upwards and because of that, there are always two good reasons not to cut a winner. Firstly, you have plenty of room to allow for normal volatility and ride that long-term trend.
Secondly, once you are up a lot, even small moves can translate to big percentage moves in terms of your initial investment. For example, if you had bought SQ at the close on the day I first recommended the stock, yesterday’s jump of around $9 would represent roughly seventy five percent of what you paid for the stock.
However, I was taught early in my career to constantly reevaluate good positions from two perspectives, and if those are applied, it’s time to sell SQ.
The firs thing to ask yourself is “Does my original case for buying the stock still apply?” This is particularly important when the initial play was based on value or potential that you believe the market was failing to consider. If a stock is up big after a year or two, the chances are that whatever that was is now priced in, making further value hard to find.
When I last revisited the position around a year ago, I concluded that despite rising by more than a third since the initial bullish piece, SQ was still value based on the original potential as a disruptor of payment systems.
The second thing to do is to detach yourself from the pride and greed that result from a big winner and ask yourself “Would I buy this here, today?” Once again, back then the answer to that question was a resounding yes. Now though, in both cases the answer is no.
The price has in fact moved way past the point where the value in that original logic is priced in. The reason for that is that Square has been a leader in incorporating bitcoin into their payment system, and so as USD/BTC soared from under $600 back in August 2016 to a high of close to $20,000 at the end of last year, and SQ climbed with it, albeit at a more normal pace. Bitcoin is now just over $10,000 though, and SQ is back to its highs around $50.
That is presumably because everyone is now buying into the story that I wrote a year and a half ago, but what it has done is to skew the risk/reward of owning SQ against you. I am not in the school of thought that maintains that a bitcoin collapse is inevitable, but it is possible, and that creates a large downside risk for Square. Their core business will remain strong and should continue to grow, but after popping on bitcoin’s rise that now looks at least priced in and that in turn severely restricts the upside potential.
So, going by the two criteria I was taught to apply when evaluating a winning position, SQ is no longer a buy. The original case for buying has been swallowed up and is more than priced in, while a forward P/E of over 65 on a stock that still has negative cash flow tells you all you need to know about value.
Mention it to somebody who has never traded, and they will think you are crazy, but it is easy to get emotionally attached to a winning position. It stokes our ego and makes us feel warm and fuzzy, but none of that should get in the way of logic, and an analysis of SQ at current levels makes it clear that now is the time to cut and run.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.