In his book, Benjamin Graham, the dean of Security Analysis, makes a very pertinent observation concerning investment in the stock market. “In contemplating the prospects of investing in the Stock markets,” he says, “companies and individuals must recognize that of all the risks worth of consideration, the highest risk lies in not having enough time, the right attitude and or correct information to make the right investment decisions.”
Every investor would have loved to have achieved the 368% growth of the IMARA stock in 2007 or the 100% in the SEFCASH stock, or they most certainly would have loved to have exited from STANCHART at P29.00 to avoid the 32% decline in the first quarter of 2008, or avoid the 27% decline in stock price of BARCLAYS and BIHL in the period ending 30 April 2008.
The ideal situation is to be able to do that year in and year out. However, that cannot always be. Moemedi Malindah, Head of Business Development at FinCraft said, “Unfortunately that is not likely; investors will win some and lose some.”
He said that the million dollar question is whether there are those who are destined to remain high or keep moving up whilst others always get wiped out?
Currently, only a few investors are able to achieve that balance, Malindah’s explanation: “only the authentic investor will achieve that balance over and over, while fictional investors will get wiped out over and over.”
“What is important is that the magnitude of the gains offset the losses incurred, and that phenomenal returns continue to be achieved. But on the contrary most companies and individuals still prefer to rely on scripts prepared for them. They take someone’s way of investing and try to emulate and, in the process, end up operating on myths as if those myths are real, and consequently they fall badly and say in awe: ‘Ah, its risky investing in the stock markets!’”
One example of such preconceived presumptions is premised on the notion that all small capped companies are risky. Numerous studies have been carried out to prove this assertion and it has been proved in different context. However, according to Malindah, most of these studies analyze the so called small capitalized stock as a basket. “In our local market, studies show that over a four-year period the volatility of daily returns of small cap stocks (FinCraft Cap index ), measured as standard deviation was 1.14% compared to 0.80% for large capitalized stocks (FinCraft Large Cap index).”
Furthermore, on value at risk (VAR) analysis, on a one year period at a 95% significance level, every P1 invested in the FinCraft Small index, 2 thebe was at risk on a daily basis and P1 invested in FinCraft Large Cap index P1 was at risk on a daily basis. This surely supports the hypothesis that small cap stocks are riskier than large cap.
Malindah maintains that, from a generalized point of view, such a hypothesis seems to hold water. But taken on a case by case analysis, it reveals a different pattern. The research shows that some small cap stocks were less volatile than large cap companies on a four year period and on a 12-month period. Data produced by the research revealed that small cap stock such as G4S Botswana and RDCP had a four year standard deviation of 0.89% and 0.69%, respectively, compared to some of the large cap stocks such that commercial banks were in the range of 1.45 1.54%.
One of the successful Fund managers in the global arena, Peter Lynch, stated that “the difference between perceived risk and real risk is where opportunities lie.”
Against this background, he said, “Investors who operate under the myth that small cap index companies are risky will fail to capitalize on the difference between perceived and real risk.”
The products in the market include bonds, money markets stocks and other alternative investments.
The FinCraft official’s advice to prospective investors is to desist from the tendency to confuse the price with the story because that is where they get it all wrong. He cautions them to adopt the right order of what to do before actually taking the decision of what to buy. The appropriate attitude emanates from following a rigorous personal investment system.
“It all starts with clarifying your personality (goal, knowledge, experience and skills. Your abilities and interests also matter) and your investment philosophy (beliefs about the market).”
With that foundation, Malindah says you can then clarify your circle of competence (that is investment you understand) and the criteria of a profitable investment. Additionally, he stated, “Whether to diversify or focus is a function of this groundwork. From carrying out this exercise you are then ready to clarify your portfolio structure.”
From this premises it follows that the prospective investor would be in a position to determine what to buy. Fictional investors, it is argued, will always try to skip this groundwork and jump right into what to buy? Despite their attitude they wonder why they always miss opportunities.
Speaking in an interview with The Sunday Standard after a one-day business conference aimed at enlightening investors on what to look for when they consider investing, he said, “Before you buy you have to be clear on your entry strategy (when to buy and what price to pay) and your exit strategy.”