One of the greatest myths of the stock market is that stocks that go up cannot go any higher and thus, have to come crumble back to Earth. Well, the truth is that the Newton’s Law of Gravity does not apply in the stock market. There are examples abound of companies that keep on going higher in share price, even though the stock price is already “too high” to begin with.
An example of this phenomenon is that of Raffles Medical Group Limited (SGX: R01), or RMG. If an investor had thought that the 52-week high of $2.00 per share in Oct 2010 was all that RMG could muster, he would have been wrong. RMG went on to chalk gains of 57% more to-date.
Vicom Limited (SGX: V01) is another example. In 2010, at a price of $2.10 per share, if you had thought the share price was already too high, you would have missed out on gains of 124% to-date. Those investors who were waiting for Vicom to come back to earth during a small correction would missed out on a return of more than a 100%.
The biggest gangbuster is Super Group Limited (SGX: S10). In February 2012, at $1.55, Super hit a 52-week high. If an investor had sold out because of this, he would have missed out on gains of 206%.
Business behind the stock price
What’s the reason behind this phenomenon? Stocks are not mere pieces of paper. The companies highlighted above are businesses that dominate their respective industries and create value for both shareholders and customers. They are also run by capable management.
It is not that stocks never undergo a correction. The point is that the stock price is a reflection of the company. If the company continues to do well, the stock price follows. If not, the stock will tumble.
Anchoring on the price
One problem many investors have is that they focus on the rise in price or the 52-week high price and wonder if there is still potential for the stock price to grow.
The investor is focusing on the price and not the value of the business. One should not anchor on the stock price but instead look at the stock with a fresh pair of eyes. Analyse the business from that point on into the future instead of looking at the past stock price movement. The investor should discern if the business is still valuable at the current price.
If a company is fundamentally sound and is churning out lots of cash, the stock price will eventually follow. As Warren Buffett once opined, “Price is what you pay, value is what you get.”
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Sudhan P owns shares in Vicom.
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One of the greatest myths of the stock market is that stocks that go up cannot go any higher and thus, have to come crumble back to Earth. Well, the truth is that the Newton?s Law of Gravity does not apply in the stock market. There are examples abound of companies that keep on going higher in share price, even though the stock price is already ?too high? to begin with.
An example of this phenomenon is that of…