In 2007, Jason Zweig, a notable financial columnist for the Wall Street Journal, wrote a book titled “Your Money and Your Brain”. In his book, Zweig attempted to address a lesser-covered topic in investing – psychology. From it, he managed to glean several interesting insights on basic biological functions, which may affect the way we invest.
To me, the most interesting insight was from Chapter 4 on predictions. He wrote:
“… when it comes to investing, our incorrigible search for patterns leads us to assume that order exists where it often doesn’t.
It’s vital to recognize the basic realities of pattern recognition in your investing brain:
a) It leaps to conclusion
b) It is unconscious
c) It is automatic
d) It is uncontrollable [emphasis mine]”
When I first read this, I found it quite shocking.
The effect of “our incorrigible search for patterns” may have the most impact when it comes to daily share price movements. Said differently, once we look at the alluring flickering lights of share prices, our brain automatically kicks in – without our knowledge – and like a little Picasso, will start painting trends around the daily price movements we are looking at.
If the patterns we imagine show an upward movement, we might suddenly feel a sense of urgency to act before we “miss the boat”. Reversely, if the patterns indicate a downward trend, the panic stricken investor may be compelled to sell and engage in “waiting for a lower price”.
The big problem, of course, is that the imagined patterns may not actually exist.
Ok, gotcha. So What?
Besides finding spurious patterns in the share market, investors who spend too much time looking at daily or monthly share prices may also miss the forest for the trees.
A great example could be found in vehicle inspection and testing company VICOM Limited (SGX: V01).
In 2008, the company’s shares dropped by 30%-plus between May and October and would have likely caused panic for anyone who was watching the company’s prices on a daily basis – the magnitude of the decline in that short span of time also suggested that the share had been sold off aggressively back then. Vicom’s share price chart for 2008 is shown below.
For ardent share price watchers, having their eye on the wrong ball (share price) might have distracted them from what’s really important – the company’s upward earnings-per-share (EPS) movement since 2007. Despite the 30%-plus drop in share price in 2008, Vicom’s EPS actually rose 18.8% in 2008. From there, Vicom’s EPS continued to rise another 68% to 32 cents for the financial year ended 2013. A chart of Vicom’s EPS growth is shown below.
Additionally, the company’s cash position actually rose from $27 million in 2008 to $78.5 million in 2013. The company also remained without debt throughout this same period.
So, evidently, vehicles continued to be inspected from 2008 and beyond, and the 30%-plus short term drop in share price ultimately turned out to be a poor reflection of the long term business performance of the company.
The long term corporate progress in Vicom hasn’t been lost to the market. Since the start of 2008, the company’s shares have generated a total return (inclusive of gains from reinvested dividends) of 404%. It currently trades at a price to earnings ratio of 20.
Foolish Bottom Line
The best-laid investing strategies may run afoul against our interests when we spend too much time looking at the flickering lights of daily share price movements. It is not possible to rid ourselves of our own brains, so it may serve our interests better if we spend minimal time looking at share price movements and instead, use that time to study businesses.
The adherence to a simple sequence – of studying the business behind the share before you even look at the price tag – might just be the answer.
Ardent Foolish readers will recall that we at the Motley Fool Singapore like to look at businesses, not tickers. There is a good reason for it, and it is the little Picasso sitting between our ears.
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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 Chin Hui Leong doesn’t own shares in any companies mentioned.