Investing is about finding good businesses, paying the right price and knowing when to bank some of the gains.

That last step can be the hardest. When a stock is rising, it is tempting to keep holding everything and assume the good run will continue. But a strong share price can change the balance between potential returns and risk.

In this week’s ASX Stock Pulse, Richard Hemming looks at why taking profits is an essential part of investment discipline, with CSL a central example.

The week ahead: Company fundamentals come first

More major US companies are due to report their third quarter earnings, while China’s GDP figures will provide another reading on the health of a key economy for Australian investors.

Bond markets also deserve attention. Sharp movements in US Treasury yields can signal changing expectations about interest rates, growth and risk.

Falling yields can ease pressure on share valuations. However, a sudden move also raises questions about what is driving investors to shift their money.

These developments provide context. For an individual stock, our focus remains on the business itself: its earnings, balance sheet, growth prospects and the price investors are being asked to pay.

CSL: A quality business still needs a valuation check

Our latest Blue Chip Value analysis of CSL highlights the importance of reviewing a holding after a strong recovery.

Whether you have owned a stock for decades or bought it more recently, the decision today should reflect its current valuation and prospects. Your original purchase price does not determine what the business is worth now.

After a substantial rally, taking some profits can reduce your exposure while allowing you to retain a holding in a business you still rate.

That is central to our Blue Chip Value approach. We want quality businesses at attractive prices, and we reassess the opportunity as those prices change.

A company can remain a good business even when its shares offer less compelling value.

Taking profits while keeping a stake

Rio Tinto is another example of this approach. We took profits earlier this year while retaining exposure to a business we continue to regard as a major global mining company.

The same discipline has informed our approach to AMP, Medibank Private and the major banks.

We have also taken profits in parts of the small cap market, including gold producer Emerald Resources and specialist steel manufacturer Bisalloy Steel.

Taking some money off the table allows investors to bank part of a gain, manage the size of a position and preserve capital for other opportunities. Keeping a stake means they can still participate if the business continues to perform.

The aim is to make a considered decision about how much exposure to retain.

Why we are watching the big end of town

Our current emphasis on taking profits is greater among larger companies.

One factor is the influence of passive investing. Funds tracking an index allocate money according to its rules and constituent weightings. Their purchases do not depend on an analyst deciding whether each stock represents good value.

This can contribute to momentum at the big end of the market. A rising share price and a prominent index position can attract further investment, even as valuation becomes less appealing.

For investors, popularity is no substitute for assessing value. When expectations change, a stock that previously attracted enthusiastic buying can suffer a sharp reversal.

Investment discipline means reviewing that risk while prices are strong.

Where we are looking for small cap growth

Alongside taking profits, we continue to search for businesses with substantial growth potential that has yet to be fully reflected in their share prices.

Some smaller companies are at the beginning of long periods of expansion. A growing market, a competitive advantage or an opportunity to sell internationally can transform a business over time.

Northern Star Resources, Evolution Mining and Afterpay illustrate the scale of growth that smaller listed companies can achieve. Finding the next success requires careful research, patience and attention to risk.

Our small cap team is focused on identifying businesses with global potential at value prices.

Keep investment discipline at the centre

The message for the week ahead is straightforward: review what you own, assess what it is worth and consider whether a strong run has made a holding too large or too expensive.

Taking profits can be part of a patient investment approach. It gives you the opportunity to realise some gains while continuing to own businesses you believe in.

At Under the Radar Report, our focus remains on buying well, managing risk and finding the next opportunity.

Watch this week’s ASX Stock Pulse with Richard Hemming for more on CSL, taking profits and the search for small cap growth.