News and Media

Picking shares: a mug's game ::

Author: Simon Hoyle
Date: 02/06/2007
Words: 2007
Source: SMH
Publication: Sydney Morning Herald
Section: Business
Page: 47

A survey discovers most investors are punting in the dark. Simon Hoyle talks to two experts.

Gemini (May 21 - June 20): Due to a rare synergy between your money and Uranus, you have a fantastic opportunity to seize your assertive emotions and make them work on your behalf. If possible, set aside the first two weeks of June for financial fine-tuning and an intensive bout of personal grooming. Monday and Friday are days when big decisions are best avoided.

Lucky numbers: 7, 33 and 45. Lucky stocks: Woolworths, Qantas and Platinum Asset Management.

MOST of us like to think that when it comes to making important decisions we gather all the information we need and make a cool, reasoned judgement based on the facts at our disposal. And that image is reinforced when we see surveys that say share ownership has reached record levels and investors are scaling new heights of sophistication.

But not everyone's buying that. Research commissioned by Clime Asset Management subsidiary StockVal provides an intriguing, and worrying, insight into how most investors decide to buy and sell shares.

It suggests that most of us are anything but sophisticated - and we're not all that well informed either. In fact, it's a wonder many investors in shares make money at all. That's a key message in the research: in a buoyant market, even a really dodgy approach to buying shares can still pay off. But the shortcomings can be brutally exposed when a market correction occurs.

The Australian Stock Exchange said in research released in May that "approximately 7.3 million people, or 46 per cent of the Australian population, aged 18 years or more, participated in the Australian sharemarket, either directly via shares or indirectly via a managed fund or self-managed superannuation fund.

"In terms of direct share ownership, 6 million, or 38 per cent of the Australian population, were direct investors," it said.

"Today's retail share investors also demonstrate greater sophistication. More investors own overseas shares and they have more companies, on average, in their portfolios: nine in 2006, compared to six in 2004, and seven in 2003. They are now more likely to include a mixture of large and small companies across a variety of sectors.

"Knowledge among retail share investors has also increased, rising by 9 percentage points, [with] 59 per cent claiming to be 'very' or 'somewhat knowledgeable' about shares in 2006, up from 50 per cent in 2004."

Roger Montgomery, a director of Clime and managing director of StockVal, says the idea Australian investors are becoming more sophisticated is "simply bonkers".

Based on 1000 responses, the StockVal research says that almost one third of investors buy shares because they've already risen in value. Half say they buy shares on a tip, three quarters say gut feel plays a role in forming their decisions, and almost 80 per cent say they never value the business before buying its shares.

A staggering 84 per cent have bought shares and later realised they didn't have enough information to know if they'd made a good decision. And 1 per cent said their decision was based on astrology or numerology. That's a small percentage, but it means there's roughly 10 people just in Clime's sample whose decisions to buy shares are based on superstition.

Ill-considered reasons for buying run the risk of setting share investments off on the wrong foot. And the reasons investors give for selling shares are likely to compound the problems.

Almost half of all investors say they have sold shares because they didn't go up in the time they expected. The same proportion say they have sold because the shares have fallen "a lot"; and the same proportion got their timing wrong, saying that they sold but later wished they hadn't.

"These are not the actions of rational investors," Montgomery says. These people aren't investing, they're guessing.

"Most people are punting in the stockmarket," he says. "They pull a lever and hope it goes up. And when it doesn't go up, they get out."

Montgomery says the findings of the survey weren't a big surprise. "I was expecting these kinds of results," he says.

"That comes from talking to a lot of people over a decade or longer, who are constantly fed this drivel by institutions that they are sophisticated. If you make people feel inadequate, if they don't feel that they are sophisticated, they won't buy your product, so [you] tell them they are sophisticated, you get them nodding, and then they will be happy to swallow whatever fund you serve up to them."

Most people are "not using professional-level methods" when making buy and sell decisions. Montgomery says investors only need to know two things to make smart investment decisions: how to recognise a great company, and work out what it's worth.

"You have to have information which provides a competitive advantage," he says. Greg Hoffman, research director for The Intelligent Investor, says investors should focus on what he calls "primary" information.

"Annual reports are number one, and any ASX release made by a company is also 'good' information," Hoffman says.

"But [investors'] information also comes from friends, acquaintances, their father-in-law or somebody else, and they may never look at a primary document."

Hoffman and Montgomery both recommend industry and trade publications as sources of "good" information. Hoffman says such publications "can be useful in terms of setting things in context", while Montgomery says not many investors read them, so they can be a source of competitive advantage for investors.

Hoffman says the internet age has made information more easily available.

"The best starting point is probably the company's website," he says. "Have a look around at its history and its products and services. Most websites, for ASX-listed companies, have an investor relations section, or a shareholder information section, where you can download annual reports. Really, the primary source for most analysis is the annual report. Montgomery says the best information is "information that not everyone is privy to". "But I think Australia, and it's shown on Anzac Day when everyone plays two-up, is a gambling nation," he says.

"The stockmarket isn't the place to do that. Boring as it sounds, there are simple ways to make substantial amounts of money in a lifetime in the stockmarket. But people always seem to be looking for two things: the path of least resistance, and the easy buck. If you do that, you're setting yourself up to fail."

Reading an annual report - not the words around the pretty (useless) pictures but the factual stuff and the numbers at the back - requires some basic accounting knowledge.

Hoffman says: "If you don't know accounting, you are starting with a big handicap. It's the language of business, and if you don't know the language, you can't know what's going on."

Once you've got all this information, you have to put it into practice. Investing then becomes a blend of art and science, Hoffman says. The science is being able to interpret the numbers and tease out the important things from the accounts; the art is in knowing what information is relevant to what companies.

Montgomery says that, at its most simple, investing is "about putting money in now to get more back later".

"The best investment is when you put the least money in now and get the most back later," he says.

"That means finding the best possible business and paying the least possible price. Valuing a business involves working out how much comes back to you and you want to pay the lowest possible price relative to what is going to come back to you.

"But very few people go out and value a business before they buy its shares." Montgomery says people often forget that buying shares is inextricably bound up in the basics of running a business. If someone were to go and buy an operating business - a newsagency, say, or a bakery - they would not "expect to make money just from it going up in value".

"You would expect it to generate a profit you can take home after you've paid all of your expenses, and hopefully be in a position where the profits from the business exceed the purchase price of the business as soon as possible," he says. "But all that logic goes out the window when people are looking at businesses listed on the stockmarket.

"Once you understand what the drivers of a business's value are, it becomes very, very easy to identify wonderful businesses. It becomes a stress-free occupation. When things get silly, you'll know they are silly: you can identify immediately that the prices people are willing to pay for that business are absurd. You can avoid it. And you can sit in the safety of cash."

Hoffman says many people go into the stockmarket underestimating what they need to know and need to do to be successful.

"I don't want to generalise but I just know, anecdotally from our business and the people who call us to inquire, I can tell by the type of questions they ask," Hoffman says. He cites the example of a caller who owned shares in CSL. The caller complained that the shares had fallen in value by $2 every day they'd held them. Hoffman asked how long they'd owned the shares. Three days, the caller replied.

"They asked: 'Does the business have any problems?'," Hoffman says. "They were not thinking about it in a businesslike manner; they bought that stock on the expectation of selling it to a greater fool. They were not investing, they were playing the greater fool game: buying something and hoping to sell it later to someone else. They just bought it and hoped it would go up."

Hoffman says deciding when to sell a stock should be as straightforward as deciding if it's worth buying. When the share price exceeds your assessment of fair value, it's worth thinking about selling. The mistake people make, however, is believing that "fair value" is a static measure, that an assessment of fair value for a share on the day you buy it will remain current for as long as you own the share.

It won't, of course - fair value for a share changes over time. Hoffman says investors have to regularly update their assessments of fair value, so they know where they stand.

"The first step is to make sure they understand what they are buying," Hoffman says. "That may sound fairly self-evident, but you would be astounded by how many people buy stocks just because, literally, a next-door neighbour, who drives a nice car, told them they should buy that stock. They don't know how much money the company makes, let alone how it makes it."

What makes the punters tick

Why and how people buy

Gut feeling played a role: 75pc

Solely on a tip: 50pc

Insufficient information in hindsight: 84pc

With information not publicly available: 15pc

Because someone in the company said they should: 16pc

Because a friend had: 31pc

Because they heard someone they respected had: 47pc

Because someone they thought was better informed had: 50pc

After a prospectus turned up in their letterbox: 7pc

On a tip sheet recommendation: 36pc