There is a certain hesitation when it comes to buying stocks that have hit new all-time highs. But by focusing on the share price alone, investors may be neglecting important aspects of the business.
Consider this scenario: You have spent a few weeks researching a company as a potential investment candidate. During this time, though, its share price has steadily risen. By the time you are done with the research and ready to pull the trigger, the stock has hit an all-time high.
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It is discouraging when this happens because most investors become anchored to the price of the stock when they started their research and are thus disappointed by the rapid share-price rise because it means they’ll have to pay more for the shares. What’s the logical next step? Should the investor consider abandoning his research and moving on to another investment idea?
Reasons for the share-price rise
Firstly, it would be useful to find out why the share price rose during the research period. Was it because of excessive optimism about the prospects of the business, or was it because of an increase in reported profits and/or dividends? Sometimes share prices rise for no discernible reason, but the idea here is for investors to at least probe further to find out if there were any catalysts that triggered the share price increase. If so, then the investor should incorporate such catalysts into his investment thesis and re-assess the investment potential of the company.
The definition of “all-time high”
Secondly, investors should also study the valuation of the company and not merely rely on the share price as an indicator of whether it is cheap or expensive. This means even if the share price hits an all-time high, the actual valuation of the company may still hover close to historical averages. This is possible because the company may be announcing record profits, and the share price is merely accounting for this. However, when measured using traditional valuation metrics such as the price-to-earnings ratio, the company may be trading at normal valuations.
Options for the investor
So, should the investor still purchase the shares? Armed with information on the state of the business, potential catalysts, and also valuation metrics, the investor can then make a more informed decision. Focusing on the share price alone is not a good idea as it may give the wrong impression of a company. Remember that when companies grow and expand their profits, their share prices can continue to make new all-time highs. There is no limit to how high share prices can go if a company continues to grow, so investors should weigh the prospects of a company’s future against the price they are paying to ensure they are confident of getting good value for the capital they deploy.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.