Page 30 - Taking Stock 22 Summer 2019

Summer 2019 Focus on the quality of the underlying business Taking Stock Investment Corner Share price volatility A share is simply a slice of ownership in a business. If you’ve started your own website, perhaps opened a restaurant, bought shares or even invested in a portfolio of businesses through a managed fund, you are now a business owner. For this reason, focus should be directed at the quality of your businesses and their prospects for the future, rather than a chart with a line that goes up and down as the price rises and falls. Unfortunately, in the nancial media, there is a focus on explaining short-term uctuations in share price. Commentators often try to attribute every little rise and fall to a particular event or issue. The risk is that an investor may start taking their cues from price movements, which are driven by short-term sentiment and emotion, rather than value, which is ultimately driven by the cash ows a business generates now and into the future. Benjamin Graham, often known as the ‘father of value investing’, famously said "price is what you pay, value is what you get". While the price of a share will certainly uctuate (sometimes multiple times per minute, every day of the year), the value of a company’s future cash ows is likely to be considerably less volatile. Speculation (that is, buying and hoping that a price will go up soon) might be considered the antithesis of investing, and shouldn’t be considered a safe strategy to build long-term wealth. If a share price falls sharply, yet the value of the business’s future cash pro ts doesn’t change, this may provide an opportunity to purchase further shares at a discounted price, hence maximising the potential return and reducing the potential for loss. A skilled investor may apply this principle to a portfolio of businesses to further reduce risk through diversi cation. In fact, signi cant share price falls may be regarded as potentially attractive buying opportunities. Volatility is the friend of the long-term investor. That is not to say share price volatility doesn’t matter. For example, retirees being forced into selling shares at temporarily reduced prices in order to help fund their lifestyle isn’t an attractive proposition. For this reason, nancial planners commonly emphasise the importance of maintaining an adequate cash reserve, particularly in retirement. Whether you are invested in a managed fund, direct shares or an investment property, price matters at precisely two times – when you buy and when you sell. Your return on an investment depends on these prices and the distributions you receive over the investment period. For these reasons, the best investors will tend to remain focused on the fundamental prospects of the underlying companies owned, and think as business owners – making share price volatility a friend, not foe. 30