Wednesday, August 20, 2014

Applying Parkinson’s Law to Investing & Yielding Greater Returns

Parkinson’s Law is mostly applied to productivity which states that work expands to fill the time available for its completion – and this means that if you give yourself a week to complete a two hour task, then (psychologically speaking) the task will increase in complexity and become more daunting so as to fill that week.

Let’s now look at how this applies to investing and yielding of greater returns. I have over the years learnt that, in the course of investing, it’s better to work smarter than to work harder. Most times, it is not the amount of time you spend on cultivating a particular investment, but it’s about how smart and fast you position yourself to make the best out of that investment. If it’s a business you are investing in, if it’s a stock or bond you are investing in, it’s always good to work with time. This is because time can change the value of your return on the investment.
 For instance, let’s say Mr. A, invested in a stock, GCB and gained 100% over two months, and Mr. B invested in the same stock but gained 100% over 10 months although he could have sold in the second month as Mr. A. If they invested the same amount, Mr. A’s gains will be valuable than Mr. B’s (holding all other factors constant) in this global economy.

I know other school of thought holds the view that, holding for long as Mr. B did in the analogy could be a bargain on stock GCB’s performance and could swing in his favour. (Let’s say: 200% profit). However, it’s good to know from the start how much time you are allocating to a particular investment and what percentage gain or loss you can take. And when you reach that level, ACT fast.

There is limiting belief that working harder is somehow better than working smarter and faster. That’s related to the idea that the longer something takes to complete, the better quality it must inherently be. But this is not the case, in investing; you have to learn to work against the clock. You have to win against the clock; strive to beat it as if it were your opponent, without taking shortcuts and producing low-quality output or low return on your investment. Cut off the time-fillers and focus on the main thing.

Sunday, August 17, 2014

What causes stock prices to change?

I remember a good friend coming to me one day all excited because according to him, one of the banks he owns shares in had announced that they had added 3 new branches to their growing branch network. He was excited because according to him, this means the price of the shares is about to increase and he will profit from it.

While my friend may not be totally off the mark in his believe, this is one area which most people find confusing. I keep getting asked this question: “what makes stock prices to increase or decrease?”

To be sincere, the answer to this question can be as simple or complicated as you want it to be. The simple answer to that question is this – “Demand and Supply”. If the demand for a particular stock (i.e. the volume investors are willing and able to buy) is higher than its supply (i.e. the volume investors are willing and able to sell), the price of that stock will increase, all other things being equal. That is what accounts for price changes in a stock.
A more detailed answer to the question can however come in this form. Prices change due to:

1.       Activities of institutional investors: Institutional investors (i.e. companies such as banks and mutual fund companies which invest in other companies) are usually responsible for changes in the price of stock. This happens because they normally transact business (i.e. either buy or sell) in large volumes, leading to the exertion of significant pressure on the share prices. For example, if a mutual fund company owns the majority shares of another company and decides to offload or sell all of those shares on the open market, there is a great likelihood of the price of those shares coming down. The reverse of this is equally true. Individuals who own large chunks of shares in a particular company also have the ability to cause price movements.

2.      Dividends or Earnings of the stock: Another factor which usually elicits enough price response from the market is Dividend or Earnings announcements. This is especially true of companies who are perceived as “dividend paying companies”.

3.      Market expectation: Generally, the expectations of market participants also cause price movements. An example of this is the story of my friend which I started the post with. So for example, if a large number of people believe that the price of that stock is going to increase as a result of the branch expansion, it is very likely to result in an increase in the price of that particular stock. This is because those people will increase their demand for that share.

Finally, I want to say that ultimately, it is investors’ sentiments and expectations which carry the greatest weight. That is what actually drives the market.

Author: M.D. Avor

Saturday, August 2, 2014

The 2 types of Investors

I was recently having a discussion with a friend who had just finished reading about the investment strategy of Warren Buffet (he is considered as the world’s best investor). My friend was amazed to find out that Warren Buffet knows to a large extent the details of the operations of any business in which he invests. In fact, it is said that, he personally visits any company he wants to invest in to find out how things are done there. According to Buffet, he does not invest in any business which he cannot understand. These findings led amazed my friend and led him to ask me a simple question: “do all investors go through this trouble in deciding where to invest?” It is this question from my friend which has inspired this post.
Basically there are 2 types of investors – the Fundamental Investor and the Technical Investor.

Fundamental Investors

Fundamental investing is considered as the “cornerstone of investing”. Investors who fall into this category make use of a number of mathematical tools. They study financial statements and the factors that affect a company’s actual business. Fundamental investors are interested in ratios such as profitability, liquidity, leverage, etc. These ratios inform their decision to either purchase an investment or not.
The greatest assumption of the fundamentalist is that: stocks do not trade at their real or intrinsic value however; in the long run a stock’s price will hit its intrinsic value. This is what motivates them to undertake all the mathematical calculations to determine the true or intrinsic value of a stock. It is that intrinsic value which would inform them about whether the stock is actually over-valued or under-valued and whether they should buy the stock or not.

Watch this space for the continuation of this post: Technical Investors. #Keep Investing

Author: M.D. Avor


Related Posts Plugin for WordPress, Blogger...