Income over Price

The first mistake most investors make is obsessing over the share prices. The second mistake is thinking that the daily price movement of their shares reflects the underlying value of the share.

The growth in your share price will not be linier, as there are many factors which affect the daily share price. The sooner you stop focusing on price the sooner you will a successful investor.

The price means nothing, by itself

 The price of a share is driven by many factors including:

 1.      the dividend paid on the shares

2.      expectations about future dividends

3.      perceptions of the stability of the company’s earnings

4.      a premium or discount based on the mood of the market

5.      the market's assessment of the quality of a company's board and management

 Let’s consider each of these factors:

 Dividends

You invest for income and compare this against the risk you are taking. Whether or not this is reasonable depends mainly on how much you would receive for your money elsewhere. We use the cash rate to measure the risk free income; the share price value reflects the premium required by the investor to take the risk on that investment. When the risk high the dividend amount needs to be high and vice versa.

The share price will fluctuate depending on the dividend, if the dividend being paid is higher than the risk applied to the share, then investor will look to invest and push the price up until it gets back to fair value for the associated risk.

For example, banks will normally have a dividend yield of 5%, if the bank trading at $20 and paying a dividend of 10% then investors will pay more for the bank up until the price increase to a level, in this example $40, where the yield will be back to 5%.

 Expectations

If people expect future dividends to be higher, they’re willing to pay more for the shares which will deliver these dividends.  This clearly would push the price higher.  A gloomier outlook would pull the price lower.  At any given time there will be investors who expect the outlook to improve and those who expect it to deteriorate. The market price reflects the net view of all different investors.

Earnings Stability

This refers to the market’s perception of the reliability of a company’s earnings.  Such companies as Woolworths and Telstra are regarded as having high quality earnings, because people will keep on buying goods and services from these companies pretty much regardless of what happens in the economy at large. 

Equally well managed companies such as Qantas have less reliable earnings.  In a slow economy, business people may travel less, and everyone can defer or skip an overseas holiday.  In a pinch, people can get by without Qantas far more easily than they can get by without Woolies or Telstra. 

Market Mood

When markets are running hot, investors seem to like every share.  They’re often willing to pay too much.  In gloomy times, some people can’t envision a recovery, so they’re willing to sell their shares for far too little.  For this reason, shares are sometimes too expensive and sometimes too cheap.  In the long run, prices are pulled back in line with the dividends a company pays.

 Board and Management

The market places more trust in the management of some companies than others.  A company which produces steady, predictable results with few nasty surprises will be more highly regarded than an accident-prone company whose board members engage in public brawls.  Even a company with a long successful history will see its share price fall if the market loses faith in the board. 

A change in board member can bring uncertainty and cause markets to look for a lower price or alternatively be seen as a positive and push the price up depending on who have been changed.

You don’t have to trade

 I’ve mentioned this many times throughout this book, but it’s so important I’ll say it again.  Most investors do best by buying good shares and then leaving them alone.

 There are opportunities to make money from trading, but these are for people who are willing to treat their portfolios as a full-time job.  Most people have neither the time nor the information to do this effectively.