Investment myths

Investment myths

Tags: Ang Kok Heng | Buy low | Buy the best | Complicated | dividend | gambling | Long-term | market direction | October | Only for the rich | Risk of losing money | sell high | Sell in May | Short memories

Written by Ang Kok Heng
Monday, 24 May 2010 10:37


There are several investment myths that are uttered among the investing public. Some of them are true, while others may only apply in certain circumstances. Some investors or punters who have experienced similar situations believe that this is the investment maxim. There are so many versions of good investment practice, so much so that investors may just get more confused after hearing all these investment myths. Further explanations could help to clear some of these myths.


Buy low, sell high
Buy low and sell high is a common advice to investors. Many know this, but few actually know how to do it or do it well. When market is falling, it is always surrounded by various negative news and investors are fearful that the worst is not over and market can fall further. As such, it is difficult to “buy low”. As long as the market did not hit the bottom, there is always a chance that it may go down further after a purchase. Similarly, selling high is also difficult to practise. In a bull market when prices keep going up, chances are stock prices will continue to go up after the disposal.

Investors must remember “buy low, sell high” is not the same as “buy lowest, sell highest”. Low is relative. It means that prices are relatively low, though not the lowest. As long as prices have fallen substantially, it poses an opportunity for the buyer. Staggered purchase is recommended in a falling market, instead of a bullet investment. If the market has fallen by a substantial amount say 20%, it poses an opportunity to invest and investors can put in some money. If the market falls further and becomes even cheaper, investors can then buy more.

The “buy low, sell high” strategy must only be used when the overall fundamentals have not deteriorated substantially. In a crisis, this strategy must be used with care. If the market descends because of changes in sentiment, then this strategy will work well.


Buy the best, and ignore the rest
For savvy investors, buying a few good stocks and ignoring the rest of the noise is a good strategy. Different investors have different criteria as to what constitutes a “best” stock. Some will focus on pure fundamentals, which may also vary from person to person. Some of the fundamentals required by investors include prudent management, business model, business prospects, cash flow, dividend yield and valuation.

The problem with this method is that some stocks with strong fundamentals may not be the favourites among fund managers; thus, these stocks remain undervalued for years. Investors buying into these types of stocks must have lots of patience for the stocks to realise their true values.


Companies that pay regular dividends are safer investments
A bird in hand is better than two in the bushes. Companies that do well must also reward investors. Dividend is a proof of cash flow and the ability of the management to manage the company’s finances. An investor who invests in a stock is seeking a return which comes in two forms — dividend and capital gain. If the expected return is 10% and dividend yield is 4%, then the expected capital gain of 6% will depend on the market. This is better than hoping purely for capital gains of a non-dividend paying stock.


Don’t believe everything you hear
In a market full of various news and hearsay, it is difficult to differentiate between facts and rumours. There are many instances where owners and syndicates who want to see higher stock prices purposely fabricate various news on potential contracts, corporate exercise, etc to analysts and reporters with the intention to mislead investors. Every piece of news must be scrutinised to determine the authenticity and its impact on the earnings. Although this could be difficult in many cases, effort is still needed to avoid falling prey to unwarranted predators.

One advice for investors is to only believe events which are more likely to happen, and only on those stocks where the management can be trusted.


Don’t try to catch a falling knife
This is a different strategy from “buy low, sell high” which postulates buying on the way downwards. In a bear market, there are also many cases where the market continues to fall like a knife. A fundamentally-cheap buy can still go cheaper due to deteriorating market sentiment. Technical chartists will advise against buying downwards, as they will prefer to see the market hitting a bottom and start to show some confidence from buyers. Each method has its merits and demerits. “Buy low, sell high” is suitable for fundamental investors aiming for long term investment, whereas the “Don’t try to catch a falling knife” strategy is normally used by shorter term traders who do not want to tie up their money in the market.



Investors have very short memories

Some believe that investors are now smarter and they have learnt their lessons, but others think that investors have very short memories and they will continue to repeat the same mistakes again and again. The fear of losing money in a bear market and greed of making quick money in a bull market come and go when market progresses from boom to bust cycle. Investors, being human, are subjected to the psychological hurdle every time the market moves into the bear or bull phase. So long as investors cannot overcome the temptation of their peers to make a killing in the market, they could fall into the same trap again. When the market plunges the unwillingness to cut and take losses will get them “stuck” with some stocks.


Investing in stocks is like gambling
Certain people believe that the stock market is like a casino. Punters will buy a four-digit stock hoping for the share price to appreciate. Some will chase after hot news and look for stocks which are actively traded recently. Fundamentals are less important. What is more crucial is that the price must go up. A good stock is defined as one where the price will soar regardless of the fundamentals. The priority of a punter is to find the next winning horse and avoid the limping horse. This strategy was popular in the past. Some may make money from good tips, but many had experienced huge losses gambling this way, and they are still licking their wounds as many of these stocks have not seem to recover at all even though the market has recovered by 50% over the past one year.


Investing is complicated
Other than relying on tips to pick the favourite stock, some investors do not have a clue as to how to select the right stock. Although experts have advised them to do their homework, study annual reports, read research reports produced by analysts, buy on fundamentals, go for prudent management, etc, they find the process too tedious. Not only do they see contradictory recommendations from different research houses, they also do not know how to decide which stock is still undervalued. Some analysts say a stock is cheap but not exciting as the growth is low. Other analysts will recommend a stock based on the net present value of its discounted future cash flow. Some use price/book ratio, price-earnings ratio, price over enterprise value, PE over growth ratio, etc. As there is no single method to judge which is a best stock to buy, investors get more confused when they start to do some research. They realised even the so-called “gurus” could be wrong too.

No doubt, investment is not easy. If it is so easy, everyone will be rich and nobody will need to work. Doing some homework may not guarantee profit but it can only help to avoid some of the investment pitfalls. Knowing what you are investing in is better than investing blindly. The additional knowledge accumulated over the years will help to reduce the risk of investment and hopefully it will lead to a wiser choice of selection.


Investing is too risky
Besides the hard work needed to commence investing, the risk of losing money may deter would-be investors. Seeing how some of their friends lose large sums of money dabbling in the stock market may imply that investing in the stock market is risky. The only safe way is to avoid this type of investment. Some have resorted to investing in unit trusts to grow their money. However, investing in unit trusts still requires certain forms of investment knowledge such as the timing of investment, type of funds and manager’s investment styles.

There is no doubt that investing in the stock market has risks. Those who do not know how to invest and do not have the discipline to follow an investment policy will continue to fail. There are also many who have invested successfully for years. Investors should follow the footsteps of successful investors who are able to grow their wealth via investment rather than be deterred by the unsuccessful dabblers who rely on luck instead to make money.


October is a bad stock month
Although Halloween falls in October, it is not a curse for the stock market. However, for whatever reason, many investment mishaps so happened occurred in September/October — the Wall Street Crash of 1929, Black Monday in 1987, 1997’s South American market crash, the Sept 11 (2001) terrorist attack, subprime crisis in US causing a black week where the US market fell by 18% in September 2008, etc. Historically, October is a bad month in terms of stock performance and it also denotes the bottom of the market for investors looking to buy for the medium term of 3-5 months.

Out of the 10 biggest one-day falls in the US, seven falls were in October. This could be a coincidence. There is no assurance that the next crash will be in October, but when it does come, it also poses an opportunity for those who believe in long term investment.


‘Predicting’ the stock market is impossible
Nobody can predict the market direction — how high it can go and how low it can fall. The general trend of the stock market is upward bias due to corporate earnings growth. Market moves in a cycle similar to the economic cycle. But it is also very much influenced by market sentiment and the flow of global funds seeking maximum returns. From time to time, it follows market fundamentals on PE valuation and earnings growth. There are also times when the market is driven by fear of changes in policies.


Sell in May, go away
This is a seasonal indicator for investors who think that summer holidays are bad for the market. If buying fund managers were on leave during this period, the market may come down. On the other hand, if selling fund managers were on summer holidays, then it may not be a bad news.

“Sell in May, go away” also denotes the six-month period from May to October where the market generally performs poorer than the other six-month period from November to April. Between May and October, the worst months were September and October. The month of May appears to be a reasonable month as far as stock performance is concerned.


Stock markets are only for the rich
Some investors believe the rich have the upper hand when it comes to investments as they have deep pockets to average down in a falling market. The rich definitely have that advantage. The limited resources of the “poor” suggest that they adopt a bullet investment style by putting all their investments in a single stock in a single day. In this way, there is no time diversification for the “poor” who have limited resources to invest. The bullet investment style is definitely riskier. For those who can afford, time diversification is preferred. One does not need to be a multi-millionaire to dabble in the stock market. In fact, small investors also have an advantage over large institutional investors who may have several hundreds of millions to invest. For one, small investors can invest in a wider range of stock without fear of liquidity constraint when it comes to selling.


The long-term always pays off
This statement seems to suggest long-term (LT) investors perform better than short-term (ST) investors. Other than the duration of investment, the strategies of LT and ST investment, may not be the same. LT investors tend to invest in low beta, fundamentally-sound investment grade stocks, whereas ST investors tend to look for higher beta, volatile and high-liquidity situational stocks. In a bullish market, ST investors could make more provided appropriate cut loss strategies are put in place. There are also many LT investors who kept a portfolio of non-performing stocks where prices continue to decline due to deteriorating earnings.

What is required is the right strategy regardless of short-term or long-term investment.

What goes up must come down
Like Newton’s Law of Gravity, “what goes up must come down”, this investment myth describes the volatile pattern of stock prices. While the price of a trading stock may fluctuate within a certain range from the mean, the price of a growth stock will continue to go up in the long run. Even if the price of a growth stock goes down, it is only temporary. Having said this, in the

This article appeared in The Edge Financial Daily, May 24, 2010.

http://www.theedgemalaysia.com/in-the-financial-daily/166634-investment-myths.html