When (Not) to Sell a Winner: Our Reporter, up 52% on Spirit Airlines, Takes You Through the Paces

It’s easy to pull the plug on a loser. No one wants a reminder of wildly bad decisions staring back at you every time you look at your portfolio. But when do you sell a winner? And particularly, how do you determine whether to sell a company that’s run up so-fast and furiously that you’ve got a 50% or 60% profit in less than a year?

That’s the happy dilemma I’ve been considering since buying Spirit Airlines (SAVE) last October at $13.97. At the time, the fledgling airline was selling cheap – at considerably less than 10 times earnings – and it was highly profitable. The company went public in May of 2011 and came to my attention a month later when writing a piece about bargains in “slightly used IPOs,” for Kiplinger.com. Here's a post-IPO stock chart for Spirit:

SAVE Chart

SAVE data by YCharts

I liked the cheap price and, as a fledgling airline, I thought Spirit had two compelling competitive advantages. It doesn’t have the legacy costs of pensions and high-priced employees that have dogged older airlines, such as Delta (DAL), United (UAL), US Airways (LCC) and even Southwest (LUV). It also has plenty of room to grow. When it went public, it primarily operated flights out of Florida into the Caribbean, but had ambitious plans to add dozens of routes. It’s also a no-frills airline that charges extra for everything. Their sales pitch is that you pay a pittance if you want only a flight, but if you want more you pay more. The airline industry is already moving to this model. I like the fact that Spirit, like Ireland’s RyanAir (RYAAY), is up front about it.

I took a look at Ryan Air’s financials before making a call, to give a little industry perspective. Everything looked good. But Kiplinger’s ethics rules require journalists to give readers plenty of time to buy recommended stocks before the staff, so I didn’t buy the shares until October, spending roughly $10,000 on 723 shares of stock. With the stock now above $21, I’ve got tidy profit of 50% or so in just nine months.

But every investor needs a discipline and mine says you’ve got to take a second look at any security that’s outpaced the market by a mile. That requires the whole “would you buy this stock today” analysis. Here’s mine in a nutshell.

Spirit isn’t as cheap as it was when I bought it. But it’s still selling for only about 15 times current year earnings and at only about 8 times estimated 2013 profits. Analysts believe the company will grow nearly 30% next year, and at about a 12% pace over the next three-to-five years. But analysts’ estimates are, well, estimated. I also look at what the company has done -- an exercise holders of, say, Apple (AAPL), should be doing regularly.

AAPL Chart

AAPL data by YCharts

Spirit’s first quarter report shows the company’s revenue was up nearly 30%. Net income was up 197%. That, however, was a bit of aberration caused by the public offering in May. Income per share was up just 6.7%, but pro-forma earnings – the company’s estimate of comparative earnings had it been public all along – indicate a 37% rise in profitability. I’m happy with a stock with a PE ratio well below its growth rate, so Spirit is passing my tests.

I also note that the company has launched 20 new routes since the beginning of 2012 and has another 12 pending and slated to go into operation before this time next year. In other words, the growth rate isn’t yet close to slowing.

SAVE PE Ratio Chart

SAVE PE Ratio data by YCharts

Spirit is also flush, with no debt and $420 million in unrestricted cash.

I’m already figuring that there’s no reason to sell this stock, but just for drill, I do a quick analysis of what would happen if I sold the stock in less than a year. That would trigger ordinary income taxes on the $5,200 gain. Assuming a combined rate of 35%, that would cut my after-tax profit to $3,468. If I wait to sell until after holding the stock for a full year, I can pay tax at the more advantageous 15% capital gains rate on my federal return (though California will still charge tax of up to 9.3%, since it doesn’t have a capital gain rate). But since state taxes are deductible, I figure the combined rate after a year is around 22%. That would leave me with a pocket-able profit of $4,056 – almost $600 more. If the stock holds up.

When should I sell? The only thing I can say for sure is “not now.”

Kathy Kristof is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

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