Friday 7 August 2015

Is Investing like Shopping?

I was just thinking about investing in shares, which has some similarities like regular shopping. Both of them look to get the most value for one's money, involve an upfront cost for possible future benefit and also, too deep discounts make us question their quality. The last point is the one that I'm going to highlight in this post.

(Image source: https://commons.wikimedia.org/wiki/File:Portones_Shopping_Mall.png)


If we suddenly saw the price of groceries selling at half price, we are likely to think that they are about to expire soon (or maybe already have). For clothes at a designer store, the clothes at a discount are likely to be from the last season or if they are in a factory outlet, may have some defect. When we see things selling at a discount to their original price we usually think that they have "lost" something that makes them less valuable.

This aspect can also be seen when investing in shares. During a downturn, as prices of shares are falling, many people are quick to jump out of the market most likely due to two reasons: they think they can sell now and buy back cheaper later or they think that the share has "lost" something and the value of it has dropped. Selling for the first reason is  a speculative move while he second reason would be an example of our thinking that just because something sells for less suddenly, it has lost something.

But unlike the examples of buying groceries and clothes, some of the shares have not actually changed during the downturn. The shares of the company still hold a similar stake in the company and the company has not changed much except maybe a change in the business environment due to the downturn but as we've seen in many downturns, they have come back up (which allows for another depression to occur in the future). While the company has stayed almost the same, the sentiments around it during a depression weakens and good investment opportunities in good companies present themselves.

We have to get rid of the mentality that price always represents quality. Just as a high priced share doesn't justify that a company is good, a low share price doesn't justify that it's not a good company. But then if we're going to go against the market when we buy while it's dropping (catching a falling knife), we have to be even more certain that we are right, or we may face huge losses.

While deep discounts in share price should not deter us from investing in the company, we should find out the reasons for the share price drop, some may be simply due to the whimps of the market working against the company (Mr. Market analogy) while there are many instances that the market was right and shares drop due to good reasons such as a new competitor that threatens market share, the industry that the company is becoming obsolete or just an incompetent management running the company.

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