PSG Angle: D-I-Y Investing ? the Opportunity and the Pitfalls
One of the drawbacks of being an asset manager is that there seems to be an inherent assumption by those outside of the industry that we should be able to determine which stocks are going to go up (or outperform) over the next week, month and year.?
Whilst this assumption may be misguided, our inability to predict short-term stock price movements not only disappoints but is often ridiculed when people who follow stocks for a hobby seem to be getting all their calls right.? Newspapers love publishing the article where the monkey throwing darts or the grade three kid doubles their money in a year on a stock pick while the investment professional ?s choice bombs.? We dread the conversation around the braai when your friend reminds you, generally quite loudly, how much money he is making on the stock you sold out of your portfolio two years ago.
One of the key theories of behavioral finance, which is the study of the impact of emotion on investment decisions, is that people generally have a tendency to overestimate their ability and are confident that they can consistently time their entry into and exit from the market.? Value-based investment management houses like ourselves fully acknowledge our inability to sustainably time the market or predict the path of near-term share prices.? We think that focusing all of our attention on determining what we think a stock is really worth, and ignoring what the herd thinks is going to happen in the near future, is a proven recipe for good long-term returns.? This means that we often sell good companies because we think the share is overpriced, not because it is a bad company.? We may underperform in the short-run but we expect to outperform in the long-run and take significantly less risk along the way.
Investing on the basis of share price momentum is a strategy that some investment managers have employed very effectively and winning stocks can outperform for a lot longer than one would think.? This is partly because an increasing stock price not only has the effect of reinforcing the confidence of those that own the stock that their thesis is appropriate, but it also attracts new investors who are drawn to a rising share price.? This is the self-feeding cycle that can result in bubbles in financial assets:? a dangerous combination of over-confidence and rising prices attracting new investors.
We unreservedly believe in the ability of equities to grow one?s wealth over time; it is our view that few investments can compound your savings over the long-run like a well-selected stock.? As long as you avoid overpaying, investing in good businesses with strong management teams can be a surprisingly simple and rewarding endeavour.? ?Hence, there is no reason that anybody doing the appropriate amount of fundamental research cannot make a good success of running their own portfolio.?
While disciplined D-I-Y investors can do surprisingly well and stock-picking can be a very satisfying hobby, there are a number of common mistakes that we all make.? These include:
- Under-estimating risk.? Newer stock market participants tend to be more focused on returns than risk. ?As a result, not enough attention is given to the likelihood of being wrong and the inherent riskiness of a stock.? One poor investment decision can wipe out the gains on a number of good calls.? The reality is that the investment portfolio (and the investor?s stomach) needs to be able to stand up to unpredictable and extreme events.? 2008 is very fresh in most of our minds.
- Failure to pick a strategy and stick to it.? It doesn?t matter whether your DNA is buy-and-hold or trader, choose your strategy and apply it in a disciplined fashion.? If you are looking for long-term gains you need to do your homework, be prepared to be contrarian and have a lot of patience.? If you are more speculative in nature, a tight stop loss is highly recommended.
- Misunderstanding valuation. ?If there is a good story around a stock or a sector the market generally knows about it.? After all, stock prices incorporate expectations for the future.? If a stock price incorporates very good news it will generate poor returns unless it can positively surprise.
- Sometimes a good company and a good stock are different things. ?Good shareholder returns tend to require good profit growth, a reasonable valuation and healthy dividends. A great brand or a great historic track record does not necessarily translate to strong investment returns in the future.
- Lack of diversification.? The future is unpredictable and aggressive exposure to a small number of companies often means that an external and unpredictable event can materially impact the portfolio.? In addition, the JSE is a very concentrated stock market with a limited number of macro drivers.? Over-exposure to single drivers such as the SA consumer or global commodity markets can introduce significant risk if economic conditions deteriorate in that space.
- Under-estimating how much value a poor management team can destroy.? Stocks are usually cheap for a reason.? A management team that allocates capital poorly or cannot be trusted to act in the interests of shareholders can quickly destroy value on a permanent basis.
- Bragging about your winners. Nothing humbles like the stock market.? Today?s rooster is tomorrow?s feather-duster.
We are not arguing against D-I-Y investing.? Whilst we always recommend?making use of the services of qualified and experienced financial advisors and investment professionals to protect and grow your savings,??we laud anyone who makes the effort to involve themselves in their investments.??What we do advise, however, is an awareness of some of the pitfalls which often ensnare the novice.? Not focussing enough on these can lead to some very expensive lessons.
About Shaun Le Roux
Shaun is a CA(SA) and a CFA charterholder. He has been managing the PSG Equity Fund since 2002. Permissions: You are welcome to reproduce this article, in whole or in part if you include the following statement "The PSG Angle is an electronic newsletter of PSG Asset Management (Pty) Ltd. To subscribe or read more, please go to www.psgam.co.za". ________________________________________© 2011 PSG Asset Management (Pty) Ltd PSG Asset Management (Pty) Ltd is an authorised Financial Services Provider (License Number 29524). The information contained in the PSG Angle is of a general nature and is not intended to address the circumstances of any particular person. We do not purport to act in any way as an advisor and you should not act upon this information without appropriate professional advice. PSG Asset Management (Pty) Ltd will not be liable for any loss or damage suffered by any party as a result of their acting on or failing to act on this information. Whilst striving for the greatest accuracy, we make no representation or warranty with respect to the correctness, accuracy or completeness of the information and opinions. Views and opinions expressed herein may change with market conditions and should not be used in isolation. The views of the contributors may not necessarily reflect the house view of PSG Asset Management (Pty) Ltd.
Source: http://www.psgam.co.za/2012/10/psg-angle-d-i-y-investing-%E2%80%93-the-opportunity-and-the-pitfalls/
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