Don’t get nervous if the market is going down! Take a sleeping pill and stick to your strategy!
The stock exchanges have gone through a rollercoaster ride of shedding 25% in value in March before rebounding sharply and even setting new highs, for example in the USA.
In view of the difficult situation due to the corona virus and the resulting tense economic situation, many investors have asked themselves whether it might still pay off to buy after recent share price increases.
As shareholder, you (co-) own the company
Buying a share means you become an owner of the company. The security literally certifies a share in the equity of the company; and in case of ordinary shares, the share also gives you the right to vote at the annual general meeting (AGM).
The share price represents the market value of the company. It tends to be significantly higher than the equity capital as shown on the balance sheet. The market value is also referred to as market capitalisation, which reflects the value of equity from the shareholders’ perspective.
Market capitalisation of selected shares:
|Company||Share price||Market capitalisation|
|Erste Group Bank AG||21.02||EUR 8.9bn|
|Deutsche Bank AG||8.276||EUR 17.0bn|
|Walt Disney Company||130.64||USD 194.8bn|
|Apple Inc.||503.53||USD 2,152.5bn|
|Deutsche Telekom||17.835||EUR 69.4bn|
|Lufthansa AG||8.936||EUR 4.3bn|
Source: Teletrader; 25 August 2020
The economic outlook of the various companies is constantly subject to re-evaluation on the stock exchange. Crucial factors for the value of the company are the business model, i.e. the prospective income of the company, its competitive situation, legal risks etc.
In addition, economic factors such as the economic cycle, inflation, and monetary policy also influence the share price. The stock exchange is often very short-sighted in its horizon, which is why market psychology enters the picture. According to an old adage, “for a bull, no price is too high, and for a bear, no price is too low”.
Do not get distracted by short-term irritations
Ultimately the share price is driven by fundamental developments. Business models that facilitate a sustainable increase in dividend or company earnings will also lead to rising share prices in the long run. Think about what themes or sectors could be interesting in the long term.
So-called mega trends like environment or technology will be among them. Alternatively, you can leave the selection of the most interesting shares to an equity fund manager. Make sure the selection process is based on fundamental considerations and simply buy an interesting equity fund.
Quality shares are always in season. We have seen many a crisis in the past. The best companies have overcome them repeatedly and have sometimes even become stronger for it. This will not be different this time around.
Transaction costs eat into profits
Every transaction creates transaction costs. Among them are of course buying and selling fees. But also, shares are bought at their so-called ask price, while they are sold at their bid price. The spread between bid (lower price) and ask (higher price) is the profit margin and risk premium of the broker or market maker, who provides the desired number of units at the respective price. Taking into account the spread and any capital gains taxes, a retail investor may well wonder whether the short-term profit is commensurate with the risk involved.
Short-term setbacks come with the territory on stock exchanges. By employing a suitable strategy, e.g. by setting up a savings plan in equity funds, you can even put setbacks to good use and benefit in the long run once prices have recovered.
It is always a good idea to keep some cash on the side – not only as iron reserve for unexpected expenses, but also for investment opportunities in securities as and when they present themselves. This way, you can exploit price corrections and achieve a lower average purchase price.
The so-called market timing, i.e. short-term buying and selling, tends to only be relevant for specialists. Traders and market makers who monitor the market on a constant basis need infrastructure to do so – ideally, in-house analysts and a designated risk management team.
Stock exchange logic and the Old Master, Kostolany
Nobody has a crystal ball that tells them when the optimal time for buying has come. It is unclear what the future holds: will a vaccine against the corona virus become available, will the conflict between the USA and China be settled after the elections in autumn, and when will the oil era come to an end?
It is best to pay attention the recommendation of the Old Master of the stock exchange, André Kostolany. He said: “On the stock exchange, 2 plus 2 never equals 4, but 5 minus 1. You just have to keep calm and outlast the minus 1.”
And he continued: “Buy shares, take a sleeping pill, and don’t look at your portfolio anymore. Many years later, you’ll find you’re rich.”
You cannot take the part about being rich literally, of course. But it is a fact that in the long run, the equity market has always recovered and reached new highs – much like in recent weeks. Do not get discouraged, keep your optimism, and stick to your strategy!
With the courtesy of Erste Asset Management as copyright owner. The article first appeared here.