RIYADH, 20 December 2004 — People are frequently dissatisfied with what they have, and believe that “the grass on the other side of the fence is greener”. They tend to seek things or situations that are better than what they have, and in the process take all comments that they hear as accurate and reliable. This is particularly evident in the investment world. If someone else buys or owns a stock, they believe that it must be good, so they follow the herd. And since they are “confident” about the new recommendation, they expect it to produce positive results “immediately”. If it doesn’t then they sell what they have just bought, and repeat the same mistake. In the process they accumulate capital losses and trading expenses.
The easiest way to invest is to “follow the crowd”, which relieves the investor from time consuming research and analysis, and decision accountability. Copying other investors might be useful under two conditions namely (1) if the investor that is copied have made proper investigation and reached an accurate conclusion, and (2) if both parties’ circumstances and objectives are similar. Investment results are judged on complete trading cycles, which are made up of buy and sell transactions. If one follows an expert for a buy transaction, he usually fails to follow him for the rest of the cycle — the sell transaction, and normally gets stuck with a loosing company. Selecting what to buy or sell is important, but equally so is when to do it and at what price. Copying although doesn’t require much effort, it usually leads to disaster.
Admitting mistakes or failures is contrary to human instincts. As a consequence when someone is asked about his investment experience he normally ignores his numerous losses — failures, and instead focuses on the few successful transactions. This is certainly misleading and harmful, particularly to novice investors. Accordingly by asking few investors one may reach a false conclusion that investing is easy and profitable. You can arrive at a more accurate picture by asking few experienced investors about the total number of transactions that they made over a specific period, and the percentage of profit or loss that each have accumulated from his portfolio.
People are impatient by nature. They want everything done immediately even if the process to do it includes high risk that might lead for their destruction. A classical example of impatience is the attraction of some people to fast driving, regardless of the speed limits or road conditions. People get a thrill from driving fast. Often the excitement dominates their ability to think of the risk and danger of driving above the speed limit. Many are lucky and escape to safety once or more times before they finally get into serious trouble. The disaster that they get into might turn out to be very harmful not to allow them a second chance or the opportunity to learn from their mistakes.
In investment, most people want to get quick profit. They buy a stock and if it’s price doesn’t increase in a week or two they sell it and buy shares of another company. They repeat this several times and during the course accumulate more losses. In the process they loose vision of the basic principle that companies performance is done incrementally through a gradual execution of their business plan — cycle. A business cycle includes time to develop a product, produce it, sell it, deliver the goods, invoice customers, collect the sales proceeds and finally generate profit. Successful execution of the complete business cycle consistently, growing the business, and meeting revenue and profit targets will make any company a good investment candidate. Consequently good news or results of outstanding performance cannot occur everyday, the way many short sighted investors want them to.
The bridge between real performance and what some short-term investors want is served by a group of companies whose share price fluctuates based on “intentions”. Such companies sell their intentions through a business plan, which might never be successful or even get executed. Investors bid the share price of these companies upward, without reflection on their real earnings. Additional investors get dragged in the bidding game, all in a short time. And the price continues to spiral upward. This “game of ignorance” — finding more fools, cannot continue forever.
If one gets in it, he is better off to get out quickly before the number of fools dries up. Sooner rather than later, the number of irrational investors get exhausted which in turn divert investor’s attention to the real world, i.e. actual performance. And since such companies don’t have any or are loaded with high expectations, you find that their share price eventually falls like a rock. In the process investors in such companies watch the value of their investment grow quickly, and all of a sudden loose most of it before they realize what went wrong. Impatience if not kept under control, can easily turn investing into a game of roulette.
(Salim J. Ghalayini, [email protected], is the author of “Stocks for the Practical Investor”. He manages several investment accounts.)