Mood Swings

How would you feel if you walked into a shoe shop and the manager rushed up and told you to buy extra shoes because prices had skyrocketed? Or if nervous customers warned you not to buy any socks because sock prices had fallen by half? You'd feel that both the manager and his customers had taken leave of their senses. Yet that's the kind of logic we see in financial markets all the time: people buying shares because their price is rising and selling shares because their price is falling.

We've been witnessing sharemarkets around the world doing both those things in recent days - sometimes both on the same day.



Read the rest at:

The herd's suffering mood swings again - Business - Business - smh.com.au

 

Hi Simon,

Buying a security simply because of how you think the price will move tomorrow is NOT investment in my opinion, but merely speculation on herd sentiment.

However, in trying to price a security you need to know how much risk.

Unfortunately with the world awash with cheap credit even conservative Value Investors find it difficult to gauge risk. This is because a company can borrow cheaply to buy back its shares and distort the PE ratio without doing a damn thing to add value to the company except add risk via borrowing.

Combine that with the fact that many investors are geared this makes the cost of capital subject to your lenders valuation of risk. In these days even banks don't care about your income stream - they only care about the price movement of the asset you have offered as security. So your costs are governed by your lender's valuation of your investments - which may be at odds with your valuation (i.e. margin call & associated costs) !!

Also, many lenders sell their debts to middlemen who package these up as securities. Trouble is the laws governing these middlemen is a bit lax. Some will package low-doc loans as 'residential mortgage backed debentures' - i.e. junk bonds by a very different name. If you can't work out the value of basic debt instruments then how can you price risk ???

So you see this debt is on a continuous merry-go-round and even the big boys like institutions and governments are getting burned as transparency disappears and repackaged as other securities. Nobody believes the rating system any more and there is a risk of a credit squeeze.

If you really want to price a company as a going concern you should ignore PE ratios & look at cash flow statements or even something as simple as the annual tax liability where it is not hiding in a tax haven. It can be quite an education.

But then again how many people actually read the financial reports ? Most don't get past the share price figures in the newspaper.

Cheers,

Rob

 

I'd say they need a smack in the back of the head..!