Focus On Value When Prices Tumble

By David McEwen

Monday 24th September 2001

In the current market turmoil, the temptation is strong to join in the panic and sell shares. However, investors should only act after they answer the question: What would Peter Lynch have done?

Now semi-retired, Lynch was during the 1980s the best fund manager in America, and probably the most successful anywhere. Under his control, the multi-billion dollar Magellan fund produced a compound annual return of 29% for 13 straight years.

His secret was to ignore prices or markets and focus on good companies showing healthy rates of growth.

He used to like pointing out that, in the past five decades, the US has seen two Presidents shot and been involved in four wars. Despite this, company earnings and share prices had increased many times.

That's not to say people should automatically hold in the face of market declines, such as we are seeing right now. However, his point is that investors should be discriminating about what they buy and sell.

Here is his list of the ten most dangerous things people say about shares:

- "If it's gone down this much already, it can't go much lower."

Not so. Too many people have held onto shares, even supposedly sound major corporates, because they thought prices couldn't fall any lower. Such confidence is often misplaced.

- "If it's gone this high already, how can it possibly go higher?"

There is a difference between price and value. Companies that are able to grow their earnings strongly generally show strongly appreciating share prices. There are several examples on the New Zealand market of companies that double in price on year, then do it again the next.

- "Eventually, share prices always recover."

New Zealand investors know better than most that some shares never recover, no matter how long you wait. There are plenty of people who are still holding onto worthless scrip from the late 1980s and are no closer to making any money now.

- "The shares are only 30c; what can I lose?"

Guess what, you can lose 30c and with small companies, rapid price movements can see much of your investment disappear very quickly.

- "It's always darkest before the dawn."

As Mr Lynch put it, sometimes it is darkest before it turns pitch black. Hope is a powerful emotion and can make people hang on to shares even when recovery is all but impossible.

- "When it rebounds to $1, I'll sell."

One has to question on what basis such assumptions are made. Again, hope or fear of loss is usually driving the decision.

- "Conservative stocks don't fluctuate much."

Wrong again. Over the past decade, many of New Zealand's biggest and most successful companies have foundered, losing billions of dollars in shareholder wealth and market capitalisation.

- "Look at all the money I've lost because I didn't buy (or sell) it."

Nobody can change the past. More important is to learn from the experience and move on.

- "I missed that one. I'll catch the next one."

Every share is different and making comparisons is difficult.

- "The stock has gone up (or down) -- so I must be right (or wrong)."

Again, this betrays a dangerous focus on price, rather than value.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. He is commissioned by the New Zealand Stock Exchange to write an independent personal investment column. He can be reached by email at davidm@mcewen.co.nz.

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