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How Rising Share Prices Can Become Painful Traps For Investors

It’s easy to say “I invest for the long term.” But, the actual application might be harder than you think, especially in the face of a share that keeps climbing.

Imagine for a moment the following scenario:

You had invested in two companies three months ago, namely, Riverstone Holdings Limited (SGX: AP4) and Q & M Dental Group (Singapore) Limited (SGX: QC7).

The long-term thesis for investing in both companies were clear to you.

For Riverstone Holdings, a maker of nitrile gloves for both cleanroom and medical purposes, you saw great potential in the rise in demand for nitrile gloves. In addition, nitrile-based cleanroom gloves could also possibly enjoy strong demand as electronic devices – such as smart phones and smart TVs – become ever more popular.

As for Q&M Dental Group, you took a fancy to the company’s duplicable business model of setting up dental or medical clinics. This can mean that its success can be recreated in new markets such as Malaysia and China, thus providing precious geographical diversification away from the company’s current main market of Singapore.

The theses behind both investments actually have a multi-year time frame, meaning to say you should have been quite comfortable staying invested in them for years to come.

But shortly after your investments were made, their share prices started rallying fiercely; today (three months after you first hypothetically bought stock in Riverstone and Q&M Dental Group), Riverstone and Q&M’s shares are up 24% and 33% respectively.

Now that’s a wonderful development isn’t it?

But here’s the thing, that sharp price appreciation in so short a timeframe is making you worried that both shares have become over-valued. There’s a strong case to be made for that too, especially considering that Q&M Dental is trading at a hefty price-to-earnings (PE) ratio of 50 at the moment.

Coming back to the real world, what would you do going forward if the imagined-scenario I described above really happened?

I might be wrong, but I guess that many investors would end up making what (at first glance) seems like a logical decision: They’d sell both shares to lock in the profit and then buy them back again when there’s a market correction in the future.

After the sale’s made, they’d then still remain very much in-tune with how both shares’ prices are moving as they’re still waiting and hoping for the price to fall so that they can buy it back again. After all, they still believe in the long-term potential in the businesses of those two shares.

And so… something nefarious then happens: They now check the share prices of both companies daily, eagerly waiting to click that ‘buy’ button at the face of a downturn.

They might be lucky enough to repeat that buy-and-sell process a number of times. Or they might not.

But what’s important to note here is the transformation of the investor from one with a long-term focus, into one which arguably has become a short-term speculator. That’s a great tragedy – that rising share price, something which should be a wonderful thing, has ended up being a painful trap for investors.

The moral of the story here is that long-term investing requires a real mental commitment. Be aware of the pitfalls that can ensnare you and divert you away from your long-term investing goals.

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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 writer Stanley Lim doesn’t own shares in any companies mentioned.