Do your homework when investing

INVESTING TIP: Investors need to do their homework and pay attention to any words of caution.

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Many people see direct share investing as an active strategy. But there are still passive elements in direct share investing for small investors, especially the high degree of trust they must have in the investments they buy. 

While the theory of share investing is that company directors are appointed by the shareholders to ensure the management of the company does the right thing, major investors also have a great degree of influence over how the company is run.

Small investors can make a lot of noise if they group together to exercise some control over things they don’t like about how the company is managed. But the most powerful strategy they have is to sell out of shares when they lose faith in management.

An equally powerful strategy is to sell investments when their prices are overvalued. Of similar importance is not paying too much for shares when prices surge above historical norms. Shares are complex investments and challenging times like the present can provide some essential lessons for investors.

Shane Oliver, head of strategy with AMP Capital Investors, says creating a portfolio of shares can be an effective investment strategy regardless of the times because it spreads risk.

The trust investors place in management is particularly important when new companies are floated, says Oliver. Compared to established companies, what new companies lack most is a track record that can help establish a level of trust. This is the major reason why they are mostly offered at a discounted price to their claimed value.

When a company is offered at a discounted price this should suggest it is capable of delivering an almost immediate capital gain to investors. This is partly to compensate for its newness, plus the absence of trust an investor might expect.

Oliver says the law requires companies that are preparing to list to point out the risks involved in investing in their shares. Management must also take great care when making any claims about the company's prospects.

This contrasts with the environment even a decade ago when some experts argued that because shares generally outperformed other investments over the very long term, their risk was equal to that of interest paying bond investments. What such claims overlook is that companies can fail and for this reason investors should demand a higher return from the shares in which they invest.

It’s a reason why investors should take note of any words of caution by companies during the company reporting period. The risks associated with share investing are real, including shares in companies that are perceive to be higher quality. What share investors can never discount is companies deciding they won’t pay a dividend.

Oliver says that while investors are presently quite cautious about share investing, the time will return again when caution is thrown out the window.

The best thing they can gain from the current market is maintaining a cautious approach when times change. It’s times like the present when investors are reminded about the real risks associated with share investing. “We get these reminders every 10 years,” he says.

Despite this many investors still end up losing when times changes and they forget to maintain a cautious approach. One share risk at the present time is value traps, where investors think they are buying a bargain and they are not.

- © Fairfax NZ News