Buying shares in a dust storm

INTERROGATE THE FACTS: THINK LONG-TERM, AND DON’T BE AFRAID TO ASK THE WHYS

Don’t buy cheap shares on a whim. Do your homework.

There’s an adage in stock markets to never catch a falling knife. Buying shares is based on the premise that the share will appreciate over time. However, this can’t be done on a whim. Investors must drown out the noise, focus on what’s known, then make an informed decision.

When you think you’ve found an opportunity, first think about the long-term consequences. Interrogate the various elements that could have a material impact on the share price currently, in the near future and over a longer period.

Steinhoff is a case in point – the share fell over 90% on news of accounting irregularities – but has since started regaining some lost ground as a new structure slowly weeds out the problems.

It’s tough to get the timing right and to make decisions in the eye of the storm – and when a once-great stock suddenly experiences a period of weakness, investors are often tempted to try to buy again at some point.

However, the reactions and confusion around when and why one should buy an incredibly cheap share come into focus as people keep wondering: is this a good share to buy?

One of the best ways to make more informed decisions is to work on your checklist. Explore why the share price is falling so fast. The answers are wide and varied. Did the stock have a poor reporting period? Is there a scandal? How has the stock done in previous months? Is this a once-off event or could it happen again?

Try to gather as much information around the “why”, so you understand why the share’s behaving this way.

Next, investigate if there has been any guidance from management. In some cases, there’s a shock event that requires management to speak out and quell the angst around their stock.

Find out if management has given an update and go through the details. Sometimes there are events that occur that are outside management’s control, e.g. a fire. Others are internal matters. The guidance from management should clarify this and hopefully give some indication of a way forward. Sometimes the direction comes a few days later – follow up. Other points to consider: Is this something management could control? Sometimes stocks struggle because of bad decision making, e.g. the Enron scandal.

Look for regulatory bodies’ response. If the fault is with management – and a scenario similar to Enron surfaces – then it’s very likely regulatory authorities will step in and issue statements. It might be worth waiting for, especially if there’s still a great deal of uncertainty around the stock and a possibility that listing rules have been violated which may lead to delisting.

Once you’ve outlined this, you’ll be able to build a more informed best- and worst-case scenario map, and make a smarter investment decision.

Don’t get caught up in a frenzy and run with market commentary when you haven’t come to an understanding of what’s going on.

Dineo Tsamela is at Standard Bank Online Share Trading. Gareth Bailey is at Pam Golding Properties.