“Why do you want to invest?” is a question that will likely prompt unique answers from every individual being asked. But for most, the objective for investing should be the same– we want the best returns we can get. For mutual fund legend Sir John Templeton, his only focus was on “maximum total real return after taxes.” Sir John was worried about taxes – because he wasn’t in the same position-of-envy that we have as investors in Singapore where there are no taxes levied on our investing gains – but he wasn’t worried about volatility in the market over…
“Why do you want to invest?” is a question that will likely prompt unique answers from every individual being asked. But for most, the objective for investing should be the same– we want the best returns we can get. For mutual fund legend Sir John Templeton, his only focus was on “maximum total real return after taxes.”
Sir John was worried about taxes – because he wasn’t in the same position-of-envy that we have as investors in Singapore where there are no taxes levied on our investing gains – but he wasn’t worried about volatility in the market over the long run. And, neither should we.
The price volatility of any particular share in relation to the volatility of the overall market is often taken to be a reflection of its investing-related risks (when it really shouldn’t be the case) and is known as beta.
It is an anecdotal observation of mine that participants in the stock market are often spooked by volatility. To mitigate their worries over volatile stock price movements, they often start hunting for stocks with low betas.
And, for investors who are focused on volatility, marine engineering firm Sembcorp Marine (SGX: S51) and instant-beverage manufacturer Super Group (SGX: S10) would have looked very appealing on 10 June 2011 with their betas of 0.37 and 0.33 respectively (calculated from their share price histories for three years ending on 10 June 2011) at that time as seen from the graphs below.
With Sembcorp Marine and Super Group’s betas, they would fall by 0.37% and 0.33% respectively if the Straits Times Index (SGX: ^STI) retreated by 1%. That’s great news for investors who are worried about volatility, right? Not so fast, buddy.
An investor who picked Sembcorp over Super Group or vice-versa would have had very different investing experiences over the next two years starting from 10 June 2011. SembCorp would go on to drop by 19% in value, while Super Group clocked 210% gains. Meanwhile, the STI remained essentially flat as shown in the graph below.
Source: Yahoo Finance
Sembcorp Marine and Super Group had very similar historical betas, or volatility, on 10 June 2011 but went on to have markedly different returns. What this means is that, investors who were too concerned with volatility of share prices would have wasted precious time and mental resources that could have been better used to understand their underlying businesses instead.
Super Group’s share price appreciation was driven by its subsequent earnings growth. Investors who drilled deeper into its business prior to 10 June 2011 would have noticed the explosive quarterly revenue growth in the company’s Ingredients Sales division (which often hit triple digit percentages) which ultimately contributed to both overall top and bottom-line increases.
On the other hand, SembCorp Marine’s shares had declined as its earnings fell. Prior to 10 June 2011, it had displayed falling revenues even though its earnings grew as margins improved. Earnings growth is always welcome, but there is a hard-cap on any company’s profit margins and earnings can only grow sustainably if Sembcorp Marine can bring in greater revenues over time. Investors who had focused on its business results might have caught on to the point.
As Foolish investors, we should know better than to worry unduly about the historic volatility of shares based on an archaic financial-metric known as beta and instead, focus on what truly matters – the performance of the underlying business.
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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 Chong Ser Jing doesn’t own shares in any companies mentioned.