Investing on the ASX isn’t that much different from investing in the US.
Companies down under might prefer to pay dividends. And American companies might like to buy back shares. But both markets tend to favour stocks with higher earnings.
And investors, whether on the ASX or NYSE, know that stocks are a part ownership in a business. So when the value of the business improves, so too does the stock price most of the time.
This is what makes markets relatively efficient. That’s not to say you can’t find huge undiscovered winners on the ASX or in the US.
But these mispriced gems do take time to find.
Cast your eye to China and investing is like a completely different sport.
To start with, a sea of red makes investors jump for joy. Red is the colour of rising stocks and green represents losers.
The name of companies also carries more weight than you’d expect.
Sometimes investors will buy a stock because it sounds right. Or a stock with the name ‘king’ or ‘emperor’ will rise on nothing more than its name.
Mom and pop investors make up the majority of the market. And forget long-term investing. According to South China Morning Post, individuals and day traders make up about 80% of the trading volume.
It’s also not unusual for stocks to stop trading all together to prevent losses. And if that doesn’t help, the national team (China’s state fund) will pick them right back up.
If this US$7.4 trillion market sounds messy, that’s because it is. And it should be any investors dream to play in such a defunct, irrational environment.
An edge anyone can adopt but few practice
You’ve probably been told before that you need an edge in the market.
You simply can’t throw your money in and expect to make returns. If it ever gets to that point, it’s probably a sign to sell before a coming correction.
Anyway…there are usually three ways to build an edge. Best part is you don’t have to have all three. You might just develop one that could still make you incredibly rich.
The first is information. I’m not talking about more information. If you’re the only one that knows where the CEO and chairman went to university…that probably won’t help you much.
The information you get needs to be relevant. For example, if you knew a company’s earnings trajectory, then that would be very useful.
Problem is, almost everyone has this kind of information. Today we have almost too much information. And this can actually lead to worse, not better investment decisions.
The second edge you could develop is an analytical one.
You might be looking at the same information as everyone else. However you understand the economics of the business better, which gives you conviction to buy when everyone else is selling.
Or you could be far better at picking apart financials of resource companies. Using your specialised knowledge you could quickly snap up bargain others tend to pass on.
These first two edges are extremely hard to come by, especially information. It takes years of experience to gain an analytical edge. And gaining information no one else has might put you behind bars.
Luckily the last edge is something anyone can adopt, but very few practice. The third edge is time.
Remember how China was full of short-term day traders? Well it’s not all that different in any other market. It’s human nature to think in the now rather than years into the future.
It’s why investors get fed up if their stocks don’t move within the month. Or why they buy into rising stocks and sell out of falling ones (because they believe the trend will continue).
It’s why hardly anyone is going to buy a company thinking about gains years into the future. If they can’t see gains within 12 months, they don’t want to hear about it.
It’s also not just individuals committing this short-term crime. Professional money managers also fall victim to short-termism. Because they are managing other people’s money, they’re under constant pressure to always perform well.
If they don’t, they risk money flying out of the fund.
The problem with thinking short-term all the time is that you miss out on some of the best rewards. How does the saying go…good things come to those who wait.
You probably can’t name five stocks that have jumped 10,000% within months. But I can name dozens that have climbed this high and higher over years.
I’ve rattle off a couple below.
Source: Yahoo Finance
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Simple but not easy
As you’ve probably guessed, it’s easier to find great investments in an inefficient market like China than it is to find great investments on the ASX.
Like the laws of gravity, investing doesn’t change from market to market. The idea isn’t to adapt and change to different investors as they play the stock market.
All you need to do is figure out what a business is worth and buy it for a whole lot less than that. Do this over time and I promise you will be happy with the results.
And while it’s not easy, you can still find inefficiencies here on the ASX. You’ve just got to be willing to look and apply some long-term thinking.
Editor, Money Morning