This is part three in SmartCompany’s five part Investing special report: The rules of investment. Written by SmartCompany and brought to you by Bendigo Bank.
Everyone wants to buy low and sell high. But if it was easy, we’d all be billionaires. Instead, we follow the herd. And make average returns as a result.
“If you follow the herd, you get what the herd gets,” says Dale Gillham, the chief analyst at Wealth Within.
As an adviser to plenty of investors, he sees most people invest in cycles, following what’s fashionable instead of searching for value.
“Right now, for example, cash is still quite popular,” he says. “Even though interest rates are so low, we’re still seeing the bulk of money sitting in cash and term deposits.” Last year, cash offered a return of just 3.98%, in a year when Australian Real Estate Investment Trusts offered a return of 32.99% on average.
The key to above-average success is to take a contrarian view. “[Billionaire investor] Warren Buffett is always saying ‘buy in doom, sell in boom’. That’s what I subscribe to. You’ve always got to be looking for the next investment vehicle, the one that’s not currently moving. By the time people start noticing and talking about something rising, it’s usually already done most of its bull run.
“You should be asking, what’s the most depressed market?”
Investment adviser and commentator Scott Pape, who hosts an investment show broadcast on CNBC called The Barefoot Investor, says he actively looks for what the major fund managers are fleeing and, if he thinks they’re wrong, swoops in.
He describes his experience with Collins Foods, which is the largest KFC operator in Queensland. In 2011, the company issued a profit downgrade that saw its share price fall from $2.50 to $1.
“We started buying it up, because it’s a really successful business,” Pape says. “What we found when we did that was that the only other buyers then were KFC franchisees, who were buying the stock. They knew it was a great brand, with strong cashflows and good dividends. When all the professionals were selling out, smart, independent investors like us were buying. We’re now sitting at a 50% gain on that stock.”
What stops people investing this way is fear, Gillham says.
Investors can feel a sense of safety in numbers, writes AMP Capital head of investment strategy Shane Oliver.
“However, at extremes the crowd is invariably wrong. Whether it’s lemmings running off a cliff… or investors piling into US housing and dodgy credit in the mid-2000s. The problem with crowds is that eventually everyone who wants to buy will do so and then the only way is down.”
It doesn’t help that there’s so much information available on people’s investments these days, which encourages people to move quickly and react rashly to new information. Gillham says: “Everyone opens up their email in the morning and gets bombarded. People tend to look just at the short-term emotions of the market. But these are just daily fluctuations. They’re next to useless.”
Oliver thinks investors should ‘turn down the noise’. There’s little evidence the explosion of information about investing has made for better investment decisions, he says.
“We seem to lurch from worrying about one crisis after another. Just think about this year: already we have seen a long list of worries starting with the US fiscal cliff, then worries the [American Federal Reserve] might exit monetary easing too early, then the Italian election, the US budget sequester, Cyprus, bird flu, North Korea, and China. The combination of too much information has turned investing into a daily soap opera.”
It doesn’t help that investors can get hung up on maximising profits rather than acting quickly when the price is right, Pape says.
“If a business is worth 80 cents, and I think the real value is around $1, I’ll buy every time, even if it could go down a little further later on.”
The opportunities in 2013
Asked what Australian asset classes are a way off their high point, Gillham nominates shares and property.
From November last year, the ASX rose for 16 weeks straight. “I haven’t seen that for 20 years. It’s extremely bullish.
“That said, I think it’s still got a way to go. There’ll be a few little bumps in the next 12 months – it’s not going to keep rising like an arrow – but if you pick up a couple of blue chips along with a few midcaps, you’ll do really well.”
When it comes to picking good stocks, Gillham doesn’t recommend investors try and do anything fancy.
“We try to get smart and pick that obscure stock at 10 cents we want to ride to $100. But the chances of that are very slim. It’s about keeping it simple. Find high-profile, very solid companies that deliver year in, year out. Take Cochlear or CSL for example – they’ve averaged over 20% per annum for years.”
Another benefit of investing in blue-chips is the dividends. For most investors, dividends comprise two-thirds of total shareholder return, meaning it’s important not to get too fixated on the stock price but instead to focus on whether the company is delivering solid results.
“Even though people get all excited about the share price, the dividend doesn’t move as much as the share price does,” says Pape. “If a company has strong dividends, the share price will catch up anyway.”
The other depressed asset class identified by Gillham is real estate, particularly in Victoria.
“There’s some great property to buy at reasonable prices, particularly in Melbourne. If you’ve got a medium-term view, there are some great opportunities.”
Ultimately, Gillham says, investors should invest in the same way they run their businesses – carefully, and with a view to unwinding their positions if the fundamentals of a business change. “Always have an exit strategy. I’ve never met anyone who complains about their shares having gone up [after they sold them], but they always complain when they’re going down. Only have contingencies for if the share goes down – that’s your exit strategy.”
It’s a view Pape shares.
“No one cares about your money more than you. If you apply the same common-sense valuation principals that you apply in your small business, you’ll make a really smart investor, no matter where the herd’s going.”
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