Investing where others fear to tread

Deciding on where to invest your money can be a daunting, scary experience. Should you follow the crowds and invest where everyone else is, or should you take a leap and invest in something a little more risky, where others are less certain of the return asks Jessica Anne Wood?

Greg Hopkins, chief investment officer at PSG Asset Management, says: “Warren Buffett, a very famous investor, talks about that one needs to be fearful when others are greedy and greedy when others are fearful when you are investing.

“Effectively what he is saying is that when people are fearful often it’s the same time when prices of underlying investments are very low. And when the market is very confident and greedy and there’s quite a rosy view on future prospects, often share prices are high at that stage.”

Greg Stockton, head of deVere Group, Africa region, adds: “Successful investing is often about going against the investment fashion or trends of the day, whether that is buying unpopular stocks or whole sectors.

“Typically wealth comes to those who buy low and sell high, which by definition means buying when others don’t want to, and selling when others think the price can only go up. Obviously some sound expertise is required to know when the price is low or high.”

Should you invest where other are cautious?

Wikus Olivier, debt review expert at Debtsafe, notes: “There must be a reason why everyone is cautious to invest in a particular company. Find out what that reason is and determine for yourself if this is the type of risk that you are willing to take.”

Andrew Newell, head of business development at Cannon Asset Managers, highlights: “Mathematically, the average investor cannot beat the market, so it follows then that if you want to beat the market, you will need to invest against the crowd, which likely is where others hold a cautious view.

“Investors should definitely consider investing in companies that others are cautious about. However, and it is important to stress this, the company must represent a sound business. An investor should not adopt a contrarian stance for the sake of it, but rather because they have uncovered an undervalued company which has not been identified by the broader market. Investors should seek out quality, under-priced shares.”

Fear and investing

It’s important that when you make investment choices that you buy with a margin of safety. In other words, you need a buffer between what the investment is worth and what you are paying for it, as this lowers the probability of losing money.

“When you talk about fear and greed, these are notions, and notions are often what drive share prices, and in an environment where there is a lot of fear often there is indiscriminate selling, people are just selling because they are fearful about losing rather than what the underlying security is worth,” notes Hopkins.

Olivier points to the famous quote: “Fortune favours the bold. The fear of others to invest or exploit a market definitely opens up doors to the ones who are bold enough to take a plunge.”

Stockton elaborates: “Fear often triggers selling by a few which can then cascade into mass-selling because many investors act as a herd. The herd mentality is infamously strong in the investment world. The more leveraged (taking on debt to invest) an investor is, the less they can afford to see markets fall so the greater the risk that they panic. Stock markets that feature many leveraged investors will be more volatile than those that don’t, creating opportunities for value-seekers when panic strikes. The expertise lies in being able to see these opportunities.”

Hopkins adds: “When you get this panic selling or this indiscriminate selling, and people aren’t really thinking very hard in terms of what they are doing that is an opportunity where you can find bargains. When there is fear, often that is an opportunity, or a misunderstanding, but often that is when expectations are low for a specific security or a specific industry, and when expectations are low, you are often going to be buying securities that are trading at discounts to their intrinsic value.”

However, Hopkins stresses that people need to be cautious of a value trap. “[This is when] expectations are low and the valuation might look low and you might think that you are getting it at a discount of the intrinsic value, but there is something fundamentally wrong with that investment, which means that sometimes one’s assessment of intrinsic value might be incorrect.”

Risk and investing

Fear is a part of investing, but taking the risk to invest is also an important step. Experts say that you should look for a good balance between risk and steady growth.

Olivier explains: “Do not look for too much short term growth. The world’s greatest investor, Warren Buffett, believes in long term growth. Higher expected returns yield a higher risk. Lower risk yields a lower return. It is therefore important to find the balance that will ensure you do not lose money.”

Olivier went on to say that “the risk factor is very important because it could mean the difference between losing all your money [and] gaining higher than expected returns. Companies have to incentivise high risk investments with higher returns in order to get investment. If you could get the same return from a low risk investment you would obviously choose the low risk route.

“It is therefore important to make sure that you fully understand the risk profile of the particular company and how they operate. Look at their management, future prospects, industry, [and] business model. Only then will you be able to fully comprehend the risk involved with the investment.”

What are the benefits of investing where others are fearful?

According to Newell, there are several benefits to investing where others are a cautious. “Inefficient pricing gives rise to opportunities. The larger the market, the more participants there are in it, the more efficient the pricing. By contrast, the fewer participants, the less efficient the pricing – and this applies to both markets and portions of a market, even a single share.

“So the fewer investors that are interested in a market or stock, the more irrational the pricing is likely to be and the better the chances of good returns. It is also true that there is likely to be less analyst insight or coverage of these parts of the market, and so investors need to exercise diligence in their assessment of these opportunities,” adds Newell.

Olivier points out: “Usually you can pick up the stock for cheap if no one wants to invest in a particular company. The risk is high but if the company grows well, others will buy in at a higher price than when you entered. This could boost the value of your stock even further. The flipside is also possible. The company can go belly-up and you could lose everything.”

The characteristics of a good investment

Hopkins reveals that PSG Asset Management makes use of a ‘three M’ approach to selecting a good investment. These are: moat, management, and margin of safety.

‘Moat’ refers to a buffer or barrier that protects the business from the competition, such as a special edge which sets a company apart from others in the industry.

‘Management’ looks at the team that is in charge of the company. “But past performance often gives you a good indication of the quality of the business and management actions and management decisions, so there is a lot of information in past performance,” says Hopkins.

However, it is important to note that past performance is not a guarantee of future performance, and things can change very quickly.

‘Margin of safety’, according to Hopkins, is the most important thing to look for when choosing an investment. “We are always wanting to buy securities at a discounted intrinsic value.”

Stockton adds: “A good investment will be determined by your personal overarching objective. If, for example, capital accumulation is the aim, it is long-term capital growth, achieved with an acceptable level of volatility. If income is the aim, reliable dividend payments that at least keep pace with inflation are key.”

“When looking to make an investment, one should seek a quality business that is available at a good price. To determine the merits of the business, look at factors such as: the quality and track record of management; the strength of the balance sheet – that it is not debt heavy; and the performance of the company through the business cycle. Other pointers would come from the shareholding: that management is invested in the company themselves; that the company is not issuing new shares and possibly even buying back shares,” concludes Newell.

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