Research cheap shares first

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 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.

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. Did the stock have a poor reporting period? How has the stock done in previous months? Is this a onceoff event? Try to gather as much information around the “why” so you understand why the share is behaving this way.

Next, investigate if there has been any guidance from management. Sometimes there are events that occur that are outside management’s control, eg. a fire. Others are internal matters.

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.

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.

Dineo Tsamela is at Standard Bank Online Share Trading.