WHEN INVESTING THERE IS ALWAYS ANOTHER GOOD OPPORTUNITY
One of the most common emotions for an investor is regret. Regret for having purchased a share that then declines in price; regret at selling an investment only to see it skyrocket; and the most common, regret at having thought that something looks attractive but just not acting and taking advantage of that opportunity. One of the most quoted Warren Buffett-isms is “be fearful when others are greedy and greedy only when others are fearful.” The good news for investors though is that opportunities within the stock market are fairly common, one just needs do your homework, to be patient and to wait for the next opportunity. In this month’s Financial View, we look at why opportunities exist and just use some recent examples.
Why opportunities exist?
Efficient market theory is a hypothesis that share prices reflect all available information and therefore shares always trade at their fair value on exchanges. What efficient market theory fails to appreciate however is that in any trade on an exchange there is a buyer and there is a seller. The exchange is just a marketplace to match these two counterparties. The buyer and the seller may have different levels of information, or they could interpret the same information very differently. Normally in a share transaction the buyer feels that the share price is below fair value, and the seller feels that the share price is above fair value.
But whilst transactions should occur on an assessment of fair value there is a bigger overriding factor influencing why investors trade. Generally, it is not what we know that induces us to trade but rather what we don’t know, or fear that we don’t know. In those instances, investors tend to behave like sheep and follow the herd. If the share price is falling, we exit out at all costs as we don’t know why it is falling, is it falling because of something they know that we don’t know? If the share price runs or is rising and we don’t know why, we buy as it appears everyone else is placing a higher value on the company which is pushing the price higher. In brief emotions, especially fear and greed influence market behaviour. It is often said that the market overreacts both ways, in times of exuberance the share price runs up above its fair value. In times of stress or fear the share price falls below it’s fair value.
Some recent examples in South Africa
Sasol (SOL)
Sasol is a company that has had an interesting recent history as a South African behemoth. In a move to diversify the revenue streams of the business the company invested in a new chemical project in Louisiana – the Lake Charles plant. Initially forecast to cost $9bn the project incurred significant delays and cost overruns. When the Covid pandemic hit in early 2020 oil prices plummeted as global trade ceased, combined with a decision by Saudi Arabia to escalate production causing an oil price war with Russia. The drop in the oil price directly impacted Sasol’s revenue, to such an extent that they wouldn’t have been able to afford the repayments of the loans on the funding of Lake Charles. As a result, people thought Sasol may go insolvent and the Sasol share price plummeted as investors fled for the exit doors. Many a savvy investor however saw through the noise and realised that whilst Lake Charles was a problem, the rest of Sasol’s historic business based in South Africa was unaffected. Sasol’s management managed to restructure their debt through the sale of some non-core assets, including 50% of Lake Charles for $2bn and the share price since climbed.
MTN
MTN was in a similar situation to Sasol. A desire to move beyond South Africa’s borders had seen the telecommunications giant expand into the rest of Africa. The Covid pandemic and subsequent drop on the oil price caused stress for MTN’s investors as a large part of the business is based in the oil-based economy of Nigeria. In fact, Nigeria clients account for one third of the revenue of MTN. Panicked investors dumped MTN shares as they were concerned about MTN getting any money out of Nigeria. As global trade opened up again oil rebounded and with it the rising fortunes of MTN.
The following chart shows the closing share price of SOL and MTN compared to the JSE All Share index from the start of the market crash caused by the Covid pandemic. The All-Share index is in light blue, MTN is in pink and SOL in the dark blue.
As one can see both MTN and SOL fell more than the All-Share index, but both have made since significant gains since their lows.
The returns can be summarised as follows:
What is clear from the table is that the crash in both MTN and SOL created opportunity for those investors that had the confidence to purchase.
Examples aren’t always as extreme as a tenfold return on an investment. Those are generally quite rare. What is more common is the short-term overreaction. Consider the opportunities that arose on the identification of the Omicron variant. South Africa was swiftly “penalised” with the introduction of travel bans and the South African stock market had a terrible day last Friday following the bans. All shares considered “SA Inc” were impacted and we saw losses in the travel sector in the region of 14% – this seems to make sense as entities like airlines and hotels will be directly impacted by reduced tourism. But we also saw share prices coming off 9% for the banking sector. This fall is a bit more difficult to understand as whilst the banks would be impacted by lower income from some of their clients, they wouldn’t have 1 in every 11 clients impacted. The huge sale in the banking sector created opportunities and the following three days have seen a 7% rebound in banking shares.
Conclusion
Because opportunities are pretty frequent in the stock market investors shouldn’t fret if they miss one. Provided that you have funds, there will always be another opportunity in the future to deploy capital and take advantage of the opportunity. As Warren Buffet reported in one of his annual letters to shareholders “Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons.” This is what we experienced last year in the middle of lock down and the covid pandemic. The risk we all face as investors is to get caught up with the general emotion. If you blindly follow the herd, you may well run the risk of buying high and selling low.
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