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Shares
Holding stock while everyone's selling
Nick Renton AM - April 2007
An old stock exchange adage is “Nobody rings a bell at the top or the bottom of the market.” The trouble is that when the market has fallen, say, 10 per cent, nobody knows whether this is the first 10 per cent of an eventual 50 per cent decline or whether the market is about to turn up again on the next day. Unskilled investors panic too easily and quit their shares at or near the bottom of a cycle, just when more optimistic investors are picking up the bargains on offer.
Later on, in the reverse situation, when the market has risen a lot, the same investors who panicked at the bottom rush back into it at or near the top of the cycle. Clearly, that is not a very good way to make money. Actually, experience shows that long term investors who buy good stocks and hold them regardless of what the market price happens to be each day do far better than those who constantly move in and out of the market, chasing the rainbow.
The latter have to get their timing right not once but twice each time - a feat that they will rarely achieve. Investors who do not panic easily also know that the stock market always goes up gradually over time - it just does not move in a neat straight line. A look at a graph of the All Ordinaries Index over, say, 30 years will show that very clearly. Furthermore, each successive peak is higher than the previous one.
In any case, if the market price of a particular share has fallen just because the market as a whole has slumped, then it is likely that its dividend and earnings per share will at the very least remain steady and more probably continue to rise gradually each year by virtue of factors such as inflation, economic growth and rising efficiencies.
Another problem faced by the “in and out” brigade is that in all likelihood, quite apart from transaction costs, they will incur capital gains tax every time they sell. Consider, for example, an investor who has bought a share at, say, 200 cents and later on after a few years sees it go up to, say, 1200 cents.
It then falls 10 per cent to 1080 cents and the investor panics and decides to quit. Tax on gains at the top rate these days, allowing for the 50 per cent discount, is 23.25 per cent, so that this tax would come to about 205 cents per share, based on the 880 cents nominal gain (ignoring charges). So that even if the investor’s theory about further falls is correct, a repurchase would need to be made at less than 875 cents (or 27 per cent less than its peak) in order for the selling investor to be better off than a straight holder. While not impossible, achieving that is a big ask.
Apart from all that, being out of the market involves the investor in a big risk. What if the company concerned announces a reconstruction or makes some other favourable announcement that sends its price up significantly? What if there is a takeover at a 50 per cent premium? It would hurt a lot to miss out on such developments when one has held a stock for a long time.
Of course, some people pay a lot of attention to the trend in a share price - believing that a stock that is rising will continue to rise and that a stock that is falling will continue to fall. In the short term they may well be right. Furthermore, one should never fall in love with a stock and continue to hold it even if circumstances suggest that it is now overpriced and underperforming. But such decisions need to be made on a case by case basis, and not because markets in Australia and around the world are down.
Whatever your views, you can discuss this article - or any of Nick's articles - on our message board Your 2 Cents.
Nick Renton AM is the founder and first president of the Australian Shareholders' Association. He is a consulting actuary, commercial arbitrator, company director and writer. He is the author of 62 published books covering shares, property, managed investments, taxation, wills, the Internet and the Australian economy. He has written books about more different topics than any other Australian author. He was made a Member of the Order of Australia in 2004.
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