Saturday, March 21, 2009

Things to Avoid in Stock Investing

My takes on THINGS TO AVOID in stock investing include:
  • Buy high, sell low @ Buy when everyone is buying and vice versa. Lets say you invest when KLCI is at 1,300 (even every coffeeshop aunty and uncle is actively buying stocks). Why not you buy when KLCI is at 800 (when the same group of people is inactive in the market)? Plus dont buy when stock price suddenly goes up a lot and sell when it goes down significantly. Nobody can predict short term stock price movements.
  • Averaging down even after the fundamentals of the company are deteriorating.
  • Listen to your broker or friends - decide for yourself, and dont blame others for your losses - because its your own action and money, not others.
  • Never cut loss - easier said than done, most investors just couldnt afford to cut loss. Set your cut loss price and just do it. Short term pain is better than long term pain.
  • Buy without target price in mind. You have to set your target price and sell some, if not all, when the stock price triggers your target price. Make sure your target price is way above the stock price, preferably above 100%. I am talking about long term investment, 5-10 years, not 6 or 12 months.

Recommended reading for weekend:

Seven pitfalls to avoid in stock investing

Mistake No. 1: Ignoring catalysts
According to Curtis, the No. 1 mistake is ignoring catalysts that drive companies’ earnings. He says proper valuation, calculating price/earnings (PE) ratios, and running cash-flow spreadsheets only provide half the picture when selecting a stock, as they merely depict where a company stands at that point in time and not, more importantly, where it is heading.

Therefore, in addition to a quantitative evaluation of a company, investors need to do a qualitative study to determine which catalysts will drive future earnings.

Take for example, Astro All Asia Networks plc. The counter, not unlike countless others, has been on a steady downtrend since January 2008.

It seemed to matter little that it was offering a dividend yield of some 7%, had cash of RM1.06bil and achieved record domestic subscriber base of 374,000 as of January this year.

While from a valuation perspective, one may deem the counter an attractive buy, but its share price kept falling. Why? Because investors were more concerned over its operations in Indonesia and the high provisions it has had to make. It recently announced a wider-than-expected loss of RM529mil for financial year ended Jan 31, 2009, largely due to losses from its Indonesian venture.

However, some analysts believe the company will return to the black in the current year (no further writedowns expected) and that it may declare higher dividends in the absence of any major capital expenditure requirement.

Mistake No. 2: Catching the falling knife
Buy when everyone is selling. That is easier said that done. Too often, investors buy in before all of the bad news is out, or before the stock stops its freefall.

“New lows in a company’s share price often beget further new lows, as investors see the shares dropping, they become disheartened and sell their shares. Waiting until the selling pressure has subsided is almost always your best bet to avoid getting cut on a falling-knife stock,” says Curtis.

In Malaysia, remember when crude palm oil prices were plunging alongside crude oil? Plantation heavyweights saw their share prices fall, which has yet to subside even now.

This time last year, Sime Darby Bhd was at RM9. Today, it hovers at RM5.55. Asiatic Bhd too was trading at RM7.40 a year ago while today it is RM4.04. IOI Corp Bhd has seen its share price drop from RM6.65 to RM3.82 on Thursday.

For investors who had started accumulating commodities or commodities-related stocks last October, they would have seen their portfolios dip by an average 30%.

For those who accumulated Resorts World Bhd last December, thinking its downside was close, especially since it hit its 52-week low of RM2.15 on Dec 12, how wrong they must have been.
The stock is now trading at its new low of RM1.92 despite its cash pile of RM4.55bil. It continues to be haunted by corporate governance and related-party transaction issues.

Looking purely at the historical PE ratio of a stock can be deceptive. More so when trying to buy a stock at its lowest historical PE. (imo, it is ok to buy a good stock at historical low PE, but it must comes with long term proven record of profitability. Why?? It is usual for every businesses, even good businesses, to experience hiccups in earnings for a year or two. And the future earnings of good businesses are going to be greater than before after a few tough years.)

“This is because if price is constant and earnings continue to drop, then the PE ratio will rise and distort the picture. You never know if you’re buying at the lowest price,” says a head of retail research at a local brokerage.

He says it is better to buy a stock when the related sector bottoms out.
“The way to gauge this point of inflection will be to compare the sectoral data with historicals during previous economic crisis,” he says.

Mistake No. 3: Failing to consider macroeconomic variables

Mistake No. 4: The issue with dilution

Another red flag to look out for are companies that issue millions of shares, hence causing a dilution in earnings per share.

Malayan Banking Bhd (Maybank) fell below RM4 on Monday, the first time in more than a decade, on concerns over its proposed RM6bil cash call and potential hefty impairment losses.
Following the announcement of a rights issue on Feb 24, the stock price has fallen 26% to RM3.98 from RM5.40.

Recall that Maybank has offered a rights issue of up to 2.2 billion new shares on the basis of nine-for-20.

The issue price for its proposed renounceable rights issue is fixed at RM2.74 per share, which represents a 34% discount to the theoretical ex-rights price of RM4.17 per share and a discount of 43% to the closing price of RM4.82 on Feb 24.

AmResearch says Maybank’s estimated earnings per share for the year ending June 30, 2010 will be diluted to 38 sen from 52.2 sen previously.

“The general perception of a company that raises capital during difficult times is that it is desperate and this will have a negative effect on its stock price,” says the retail head.
Curtin instead advises to try seeking companies that are repurchasing stock and, therefore, reducing the number of shares outstanding. This process not only increases earnings per share but also tells investors that the company feels there is no better investment than its own company at the moment.

Mistake No. 5: Not recognising seasonal fluctuations
Most sectors go through booms and bust. In other words, they are cyclical. Investors looking for stocks to buy, need to take into account the sectors that are at present in vogue.

For instance, would it be a good idea to invest in the semiconductor sector, knowing full well there’s a major slowdown in chip sales and a case of layoffs and inventory building up?

In the case of the retail and consumer sector, their sales go up and down depending on which part of the year it is. The year-end school holidays and festivities normally see sales picking up. At other times, sales are fairly staid.

Similarly, would it be wise to invest in a property company when the sector has gone through a five-year bull market, and will probably need to undergo a period of correction before it rises again?

“The fact is that many companies, such as retailers, go through boom-and-bust cycles year-in and year-out. Luckily, these cycles are fairly predictable, so do yourself a favour and look at a five-year chart before buying shares in a company,” says Curtis.

Mistake No. 6: Missing sector trends
While stocks can buck the larger trend, this behaviour usually occurs because there is some huge catalyst that propels the stock.

For the most part, companies trade in relative parity to their peers. This keeps the stock price movements within a trading band.

Let’s say an investor owns a banking stock in Malaysia. While Malaysian banks are not exposed to the huge debts and toxic assets of Citigroup, American International Group or Bank of America, Malaysian banks may likely be affected in a protracted downturn.

Not surprisingly, Public Bank Bhd, Maybank and Bumiputra-Commerce Holdings Bhd have come under heavy selling pressure on negative newsflow and a worsening economic outlook.

Financial valuations in Malaysia have pulled back substantially from a peak of 2.5 times price-to-book (P/B) in January 2008 versus 1.2 times P/B currently.

Hence, if other banks are experiencing certain negative perceptions or problems, most likely the Malaysian banks will also be affected. The same is true if the situation was reversed.

Mistake No. 7: Avoiding technical trends
Learning basic technical analysis can be very useful when deciding to take a position in a stock. For instance, would you bet heavily on stocks on Bursa Malaysia when the Dow Jones Industrial Average is trending down every day? Curtis says investors don’t have to be a chartist to be able to perform technical analysis.

“A simple graph depicting 50-day and 200-day moving averages as well as daily closing prices can give investors a good picture of where a stock is headed,” he says.

He advises investors to be wary of stocks that trade close to their average as it usually means it can sink even lower. The same can be said to the upside. Also, when volume trails off, so does the stock price.

“Sticking purely to fundamental analysis can be detrimental to one’s portfolio,” says the retail head.

He says technical analysis measures the real demand and supply for a particular stock. “It helps guide investors to determine the exit and entry points,” he says.

Can we use technical analysis to predict future stock price movements? Or technical analysis is just useless? More on my mistake using technical analysis in the next article.

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"There is the plain fool, who does the wrong thing at all times everywhere, but there is also the Wall Street fool, who thinks he must trade all the time. No man can have adequate reasons for buying or selling stocks daily - or sufficient knowledge to make his play an intelligent play." - Jesse Livermore