BOURSE SECURITIES LIMITED

Most investors involved with having some exposure to equity investment will tell you the experiences and lessons they learnt during the course of their investment life.

Whether it be through learning from other people’s mistakes or learning the hard way through hands-on experience, most investors come to one consensus when it comes to the lessons that were learnt from the very volatile equity markets.

1. Momentum buying

One of the mistakes most investors are guilty of is buying a stock purely on the market’s momentum and not conducting the necessary research. This strategy results in a missed opportunity where you may be purchasing the stock at a high price only to realise at a later date that the stock’s momentum has ended and is on its way down.

Many investors tend to see a stock moving with an upward momentum and purchase on this basis. What we all must keep in mind is that what goes up always comes down at some point in time. Many local investors may have fallen into the trap in 2005 when the local market was on a rapid rise.

At current prices many of these stocks such as Guardian Holdings Ltd (GHL), Republic Bank Ltd (RBL) and Trinidad Cement Ltd (TCL) have yet to break even.

For example, an investor who would have bought into GHL on January 1, 2005, when the market was running up would have paid $35.10 per share. This investor would still be trying to recoup his investment since the current price of GHL stands at $30.25.

2. Alternate opportunities

The market is a huge place filled with tons of great opportunities. Just because one great opportunity is gone doesn’t mean there aren’t any left.

There are a number of other opportunities out there which have high upside potential which is dependent on the company itself. If you missed the train, that doesn’t mean you can’t get on the next one coming. In the past few weeks the momentum on the local equity market has begun to retract.

The investor who may now be willing to take his gains in certain local equities has a variety of uncorrelated investments available which can earn decent returns, such as fixed-income instruments or energy-type investments.

With global commodity prices already starting to retreat, investors may soon find a lucrative investment in these commodity markets.

Additionally, there are various local energy funds in which the investor may want to participate when the timing is correct.

3. Too much greed

Buying stocks is easy. Anybody can do that. The hard part is knowing when to sell and very few people know how to do that. We’ve all fallen victim to making expensive mistakes, either missing the full upside by selling too soon, or taking a huge loss by holding a falling stock too long.

An investor must know his limits. Knowing when to exit a position is just as important as knowing when to enter. Seeing your stocks reap a 50 per cent return within one month is very hard to let go of knowing that there’s the possibility that that 50 per cent has a probability of turning into 100 per cent within a few months. However, just as quickly as you gain returns, you can lose returns as well. That’s why developing an exit strategy and sticking to it is important.

By continuously wanting more constantly deviating from your exit strategy, where instead unrealised gains slowly turn into unrealised losses thereby missing the opportunity to book profits.

For example, as a result of the market momentum which started in the earlier part of the year, locally listed companies Scotiabank T&T Ltd (SBTT) and ANSA Merchant Bank Ltd (AMBL) have experienced year to date price appreciations of 43 per cent and 59 per cent respectively trading at multiples of 17 times and 15.5 times in that order.

With the market momentum slowing down and not much more upside potential expected, now would be a good time for the investor to book his profits and seek out more attractive growth opportunities.

Some investors use one of the following techniques in developing their exit strategy whereby if one of the following occurs, exiting the position takes place:

n Your profit objective for the trade is realised. (eg price target of 20 to 25 per cent within one year has been met). This draws us back to the previous example of SBTT and AMBL whose stock prices achieved rapid growth within a few short months.

n The expected catalyst fails to develop or the stock fails to respond as anticipated. A perfect example of this can be seen in the events that unfolded after investors began receiving cash consideration from Royal Bank of Canada for their RBTT shares. Investors were expecting a second jolt to the local market with the entrance of this cash. However, the increase in demand and activity on the market which was expected never really materialised.

n The stock fails to respond within a predefined length of time (eg the stock did not come close to reaping the expected returns that were anticipated over the pre-determined 12-month period).

4. Excessive leveraging

For many investors, utilising margin to buy more stock can be tempting and the rewards can be high. However, excessive leverage can knock you out of the game permanently. Leveraging introduces you to a whole new world of debt where, in an already high risk equity market, you introduce yourself to an added risk if not utilised properly.

In order to make money on leverage, an investor must generate a return that can beat the amount he pays in interest. If you must borrow on margin, ensure that you always leave yourself plenty of breathing room to avoid a margin call.

An investor may be correct about a stock in the long run but in the short run, the market may swing against him. He may find himself having to sell most of his position to help cover his debt, only to realise later that he was right about the stock and had held on to it.

However, even if you think you found an amazing stock at a very cheap price, that stock could keep going down. In the short run, the market is highly unpredictable and variable.

A simple worked example would reveal the following: had an investor requested funding at the beginning of the year to purchase securities (bought on margin) in the amount of $100,000 he would have paid an annual rate of interest in the vicinity of 11.25 per cent, making his total current cost equal to $107,500.

With the upswing in the local market, let us assume that the mix of stocks purchased by the investor with these funds earned an average return of 30 per cent. Should the investor now decide to book his gains, he would be $22,500 richer.

5. Buy on fundamentals

In buying a stock, you are literally buying a piece of a company where you become an owner of that company. You should not leave your money in a company you don’t know anything about.

Though a company may look like a diamond in the rough, always make sure to analyse its fundamentals before making hasty decisions and buying its stock. Simply taking a glimpse of the company’s annual report can give you a whole new insight into its operations and where it is heading.

Valuation ratios such as the price to earnings ratio (P/E), or price to sales (P/S) ratio, define how market participants view the company’s earnings growth prospects. There are two types of investors: growth investors and value investors.

Growth investors tend to purchase stocks with high growth potential where the company’s earnings are expected to grow at an above average rate when compared to its industry and the market as a whole. Some local examples of growth stocks include Republic Bank Ltd, ANSA McAL Ltd and Neal & Massy Financial Holdings Ltd.

Value investors tend to purchase stocks with low valuation ratios so that when the market eventually realises the stock’s worth in the long run, the stock’s valuation will eventually be reflected in its price, presenting the investor with an opportunity to sell at a profit (buy low, sell high).

Some local examples include Neal & Massy Holdings Ltd, which can also be considered a growth stock as mentioned earlier, and Sagicor Financial Corporation.

Value investors recognise that equity market investments are a long-term investment and they carefully chose a stock based on the long-run fundamentals of the company.

Many investors argue that growth investors and value investors are opposites in their investing views. However, as the investment guru, Warren Buffett, has so eloquently said, “growth and value investing are joined at the hip.”

6. Spread the risk

It’s also important that diversification occurs not only among asset classes but within the same asset class as well. Having exposure to only one stock market and thus one country is not advised.

Diagram 1 depicts the returns for an investor who decided to invest in both the US and T&T stock markets at the beginning of 2003. From the diagram, we can see that the period November 2005 through March 2008 has been a tough period for this investor, producing negative returns.

However, through diversification via country allocation, the investor would have been able to offset these losses in the local T&T markets by the positive returns he would have gained in the US markets for the given time period. We can thus see the importance of not putting all your eggs into one basket which is also advised within asset classes.

Conclusion

One of the best ways to become a better investor is to learn from your mistakes and other people’s mistakes as well. Having a strong investment plan and sticking to it despite the urge to deviate proves profitable in the long run. Your financial adviser can help develop a plan that’s best suited to your goals and objectives.

askus@boursefinancial.com or phone 623-0415/0416 /9360