As we grapple with the current bear market at the Nairobi Securities Exchange (NSE), most investors may be inclined to succumb to panic selling and avoid investing, to their own disadvantage in the medium to long term.
The end may not be in clear sight but to value investors, the opportunity to buy great stocks on the cheap is enormous.
Humans are creatures of habit and as a rule we gravitate towards what we feel or perceive to be the safest environment for survival. This situation is replicated in investment habits as we rely on the laws of probability to make our choices.
We are thus prone to following trends when making these decisions since in our psyche we are programmed to assume that the herd is probably right.
For this reason we say that, “Bull markets feed on themselves” eventually creating euphoria and, “Bears feed on themselves” eventually fuelling panic.
Bull markets fuel greed. Investors act on price action rather than value, which builds up to euphoric proportions culminating in market bubbles.
These bubbles are recognisable when valuation metrics overtake fundamental growth projections, market indices keep hitting new record highs and investor sentiment is at its highest. It isn’t surprising that in bullish times, public issues abound.
Most market corrections happen soon after record initial public offerings like Safaricom in 2008, AT&T in 2001, Microsoft in 1986 and Alibaba Group in 2014.
Fear on the other hand is the result of the underlying risk that stocks represent.
Chinese symbols depicting risk stand for danger and opportunity, referred to as the risk versus return tradeoff in finance. Simply stated the higher the risk the higher the probable returns.
A classic example is how frontier markets like the NSE are considered more risky by investors from more developed markets like the US and UK. They would only be attracted to invest here if the potential returns outweigh the underlying risk.
Even “risk free” securities like US Treasury Bills yield 0.26 per cent while the Central Bank of Kenya’s 90-day T-Bills is currently yielding 11.343 per cent, a clear indication of how underlying risk is priced into securities.
Digging deeper into fear you will find a more psychological aspect of how it works. Ask any investor what they fear most when investing and the most forthcoming answer is “to lose money.”
Yet a closer look at investment patterns indicates that most investors tend to buy into stocks when they are overpriced and avoid trading towards the tail end of a bear market, like now when opportunity abounds.
This points to “fear of losing out” rather than fear of losing. A classic sales and marketing gimmick is the creation of a sense of scarcity, like signs on buildings stating 95 per cent sold and matatu touts shouting “Beba wawili twende” when there are in fact 10 empty seats.
This also happens when stocks are trading at their highest prices – when news on market performance tends to be most positive, when shares are trading at higher highs every day, record IPO issues are being oversubscribed and everyone you know is bragging about how much they have made on stocks.
Legendary value investor Warren Buffet said: “For some reason, people take their cues from price action rather than from value. What doesn’t work is when you do something that you don’t understand because it worked last week for somebody else. The dumbest reason to buy a stock is because it is going up”.
It follows that the sophisticated investor should ignore the noise and concentrate on the intrinsic value of the asset that they are seeking.
Buffet also says, “Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.”
Financial risk judgment involves combining both science and human intuition, which involves questioning what we observe or what we are told, checking whether our data sources and assumptions are reasonable and finally assessing and weighing the expected financial result versus the consequences of an unexpected bad result.
Try to always figure out the opportunity that lies in any investment despite the underlying danger. You will want to know the state of the economy, who runs the company, what the industry forecast is and how innovative the firm is. This will help you avoid toxic value traps.
I have seen many people buy a stock simply because it is cheap and live to regret it as well. This finally brings us to the long term fallacy. Just what is long term investing?
One way of thinking is to “never take money out of your investment account” or to “invest for the long term”.
Long term investing is hugely misunderstood because many people will buy a stock, get a gain of 30 per cent in three months, not sell it because they are long term investors only to see it lose the 30 per cent in the next three months.
Microsoft is a classic example. If you bought 100 shares at the $21 offering price in 1978 and sat on the investment for 25 years, it would have mushroomed into 28,800 shares over the course of nine stock splits and be worth about $750,000 today.
Here’s the disheartening caveat: Had you instead sold your stash on December 1, 1999, when Microsoft stock price reached its peak, you would have reaped $1.4 million – 13 years: + 66,566 per cent return.
Instead of drooling over paper gains, try to realise your profit by selling or earning a dividend and reinvesting the returns. The power of compounding means your returns can then earn more profits.
Your broker can help you set objectives and benchmarks against risk-free assets to guide investment decisions.
That way when a target is reached it acts as a signal to sell and if a loss is made, it triggers a review on whether it is wise to average down or cut losses depending on the underlying reasons for the decline in value.
– Samuel Gichohi, a business development manager at NIC Securities.