Why it’s not wise to buy high flying stocks

11 Jun, 2021 - 00:06 0 Views
Why it’s not wise to buy high flying stocks Getbucks has been the ZSE's top performer since May — afx.kwayisi.org

eBusiness Weekly

Kudzanai Sharara

A few days ago, through my Twitter handle, I tweeted about a certain Zimbabwe Stock Exchange listed stock (Getbucks) that had gone up by more than 3 300 percent in just four months.

I gave an example and said if one had invested $50 000 into this particular stock, the value of those shares would have jumped to a staggering $1 650 000.

For those of us who look at things in US dollars, this could have been a US$500 investment turning into US$11 000.

Interestingly, Getbucks is not even the top riser on the ZSE this year. It is Unifreight and a $50 000 investment made in January this year would be $3 454 000 (US$40,635) at the official exchange rate. Slightly less at the parallel market exchange rate.

Whatever exchange rate one chooses to use would give a very staggering return.

But that’s not what I want to write about today, so back to my tweet.

Following my tweet, I received floodgates of direct messages (inbox). People wanted to know which stock I was writing about, while others wanted to know which other stocks they should be buying for similar returns.

I quickly noted the attraction was on the gains Getbucks has recorded to date. Very few wanted to know why, or whether the share price is justified by strong company-specific fundamentals.

In stock market Whatsapp groups, a lot of retail investors were disappointed they had not bought Getbucks. The reasons why they had not bought it in the first place were quickly forgotten.

Many people wanted to enjoy such high returns but very few wanted to go through the process.

Last year, both Getbucks and Unifreight were among the worst performers on the ZSE.

CBZ Holdings was the best after its share price went up by more than 12 000 percent. Its upward trajectory attracted a lot of investors.

Some bought at its peak. Today most who bought CBZ Holdings this year are not a happy lot.

If that $50 000 had been invested in CBZ, that investment would be valued at $48 235 as of Wednesday this week. If we factor in inflation and exchange rate depreciation the loss position is even bigger.

The lesson here is that investors should not let share price movements their sole basis for investing in a stock.

Once a share price has scaled such highs, one would be taking a huge risk to buy at such high levels. Yes, there is a possibility that Getbucks can continue to soar or even double the current share price, but the risk is also high.

So if I am not encouraging investors to buy into stocks that are outperforming others, share price-wise, what then should buyers consider in their share purchase decisions.

In my view, shares should be bought based on the investors’ understanding and conviction of the business model of the company.

Two of the most important factors that must inform buying decisions are how the company makes its money, and whether it is making lots of money?

One of the world’s most successful investors Warren Buffet is not concerned with how well the company’s share price is doing at the time of buying but is concerned with how well that company can make money as a business.

In other words, he looks at the company’s ability to generate earnings at an increasing rate each year. He seeks first to identify an excellent business and then to acquire it at the right price.

Another aspect that should inform a buying decision is whether the stock has any competitive advantage over its rivals.

Consumer monopolies are some of the businesses that come to mind. Does the business offer products or services that its competitors would find difficult to reproduce or substitute?

Also to consider is whether the business’ products or services are always in demand and the target company has a competitive advantage. Would customers choose the company’s products over others? These are some of the questions that can help make an informed decision.

Other things that can be considered include but are not limited to whether the company’s revenues and profitability are growing.

In addition to being profitable, there is also a need to consider whether the margins are healthy in comparison to other industry players.

The company’s debt-to-equity ratio also needs to be looked at. Being over-leveraged can limit a company’s choices in making business decisions.

The lower the debt ratio, the more a company can take risks without the worry of defaulting on its large debt load.

All these aspects will also help in getting the company’s true or intrinsic value. Although companies can trade at a premium to their intrinsic value buying above such levels also carries an increased risk of losses than buying below the intrinsic value.

Most retail investors might not have time or knowledge to understand all this, but it’s better to trust that process than to chase high-flying stocks.

It’s better to start with the basics and learn as you go. The most basic is to buy stocks that one understands how they make their money and are also dominant players in their industries. They might not give the most outstanding returns, but they are also unlikely to result in huge losses.

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