On Wednesday the 6th of December, the world woke up to the news that the Chief Executive of an R240bn company, Steinhoff, had abruptly ‘resigned’. Further news of a probe into ‘accounting irregularities’ flooded the news cycle. Over the next 3 days, the company’s share price plunged from R45 to R6! This cost investors over R150bn. With the share price having lost 87% of its value, was this the perfect time to buy Steinhoff shares?
Buy low – sell high
Investment “fundi” often say that you should always buy low and sell high. That’s how you make money on the stock exchange. But – what exactly is low and what is high? Was the price of R6 per share low? Would Steinhoff’s share price continue to fall, even lower than R6? What if you bought the shares and the following day the share price went down to R1? What if the company collapsed completely?
When low gets lower
In 2014, a friend of mine bought African bank shares after the share price had fallen more than 50%. My friend believed that the company’s shares would make a comeback and he would make a killing in the process. The share price did not recover. It declined further. The JSE halted trading when the share had been traded down to almost zero. After regulatory intervention African bank was split into what was called the ‘Good bank’ and the ‘Bad bank’. Shares in the good bank went on to increase 100% over the following 2 years from a starting price of R32. How many investors would have held onto their shares during this entire turmoil?
In the week after the ‘great plunge’, Steinhoff shares showed signs of recovery – gaining back some of the lost value. Investors who had bought the shares at the R6 level were making profits of about 50%. At the same time, the South African parliament was calling for investigations into Steinhoff and the Johannesburg Stock Exchange had launched a probe. The company’s share price was still at risk.
Dollar cost averaging
See, the thing about buying low and selling high is that the average investor and even professional investors cannot truly tell if a share price is high or low. Only in hindsight can you really tell. An alternative method of choosing when to buy shares is called ‘Dollar Cost Averaging’. ‘Dollar’ because it’s a concept made popular in America. You can call it Rand cost averaging or Pula cost averaging, whatever your currency is.
This method simply says you should choose what you want to invest in as a first step. Having chosen the asset, you invest a fixed amount of money at fixed intervals. As an example, you could choose to invest R20,000 in African Rainbow Capital shares. Instead of waiting for the share price to become ‘low’ you could choose to buy R5,000 worth of shares every month for the next 4 months. You do this regardless of what the share price does. The only requirement is that you truly believe in the long-term value of the company you invest in. This approach ensures that you adopt a long-term investment outlook instead of speculating on price movements.
Buy high, sell higher
Cost averaging in effect implies that you should buy shares when you believe in the long-term value of the company and sell when the price goes higher. There is a place for speculation and you could make a lot of money from it. You could also make great losses though. If you want to be a long-term investor, then dollar cost averaging is a better bet.