How do you move old jewellery fast?
One day, owner of an Indian jewellery store stumbled upon an ingenious way.
She simply increased the price.
That’s right. Anything that’s not selling flies out the door once marked up.
If you’re the economist type, this probably sounds strange. Why would increasing the price increase demand?
Surely jewellery is a very elastic product? Meaning demand depends heavily on price.
Yet when tourists wander into this Indian jewellery store, they go crazy for high priced turquoise. After a while, she decided to get an answer as to why this was the case.
She called her friend and psychologist, Robert Cialdini.
If the name sounds familiar, it’s because Cialdini is author of the incredibly popular book Influence. And in his first chapter, he decided to explain why tourists loved high priced turquoise.
Rising prices doesn’t mean rising value
The tourists were associating price with value, Cialdini wrote. He states:
‘The customers, most well-to-do vacationers with little knowledge of turquoise, were using a standard principle – a stereotype – to guide their buying: “expensive = good.” Thus the vacationers, who wanted “good” jewellery, saw the turquoise pieces as decidedly more valuable and desirable when nothing about them was enhanced but the price.
‘Price alone has become a trigger feature for quality; and a dramatic increase in price along has led to a dramatic increase in sales among the quality-hungry buyers.’
Of course this isn’t how it always pans out. But it’s a simple and interesting psychological trait nonetheless.
What does this have to do with investing?
Well, consider we’re not talking about tourists buying turquoise. Instead imagine we’re talking about investors buying stocks.
A high price, or rising stock price is self-validating to some investors.
Take GetSwift Ltd [ASX:GSW] as an example.
The logistics software company was signing deals like no tomorrow. They had announced a dozen new contracts. Such activity, you’d think would push earnings far higher.
Add on top of that GetSwift’s ever rising stock price in 2017. And it was this rising price which encouraged many investors to buy in.
I can only imagine the thoughts going through their heads…
The stock price is going up, which means other investors must like the stock. They’re growing like crazy, and analysts believe that growth will continue going ahead.
But it wasn’t long before that all came crashing down. The company didn’t update investors about losing two large contracts. They were also a little too optimistic when estimating future sales.
Source: Google Finance
[Click to open new window]
Those who bought in near the top last year saw almost 90% of their cash disappear.
Had investors been more sceptical about GetSwift’s vague announcement, they might have thought twice before buying the stock.
Yet the price was screaming up, which to most investors was a sign of a quality company.
You could say the same thing happened with bitcoin last year.
The cryptocurrency enjoyed initial success, and then went on a tear towards the end of last year. One look at the price chart was enough for most investors.
They saw the ever-climbing price and didn’t want to miss out on what could be.
Again, the problem was confusing price with value. So in an effort to avoid becoming the tourist buying high priced turquoise, let me explain the difference.
Price is what you pay, value is what you get
A quick quiz from South China Morning Post (SCMP):
‘Which of these is the best performing asset class so far this year?
‘1. US stocks
‘2. Hong Kong-listed H-shares
‘4. US Treasury bonds
‘5. Chinese government bonds’
Had you said 5, you would have been right. Yet it matters little.
‘If you had had the foresight to invest US$100 (HKD$785) in seven-year Chinese government bonds on December 31 last year, at the end of May your investment, including coupon payments, would be worth US$105.
‘That might not sound like a huge gain. But it’s better than H shares, the Hong Kong-listed shares of mainland Chinese companies. Including dividends they have returned just 3.1 per cent.
‘It’s better, too, than the US stock market, where your US$100 would now be worth US$102.65.
‘Meanwhile, in gold your US$100 would today be worth US$99. And in US Treasury bonds, formerly the world’s favourite safe haven investment in troubled times, it would be worth a paltry US$98.70.’
Why doesn’t it matter? Unless you have a crystal ball, how could you know Chinese bonds were going to be the best performer within just months?
And while they’re outperforming in 2018, who’s to say that record will continue?
If we look at this from a historical perspective, you wouldn’t want to hold any type of bond over your investing life. The returns from stocks are simply far better.
A step up from that would be to invest in extremely valuable stocks.
What does that mean? It means the value of the stock is worth far more than what you can buy it for in the market.
Think of it like a private business owner. If you bought a business for $6,666 that spits out $1,000 in profits each year, you’re making a cool 15% return on your money.
If someone comes along and offers you $8,000 for the business, would you sell?
Probably not. Your 15% annual return would turn into a one-off 20% gain.
But what if their offer was $15,000? Well then you’d be looking at a one-off gain of 125%, which you could reinvest into another high returning business.
Prices like the above are thrown at investors daily. And more often than not, it leads to bad decisions.
So instead of focusing on price, try to determine the value (or potential future value) of the stocks you own. Then, when an attractive price comes along, you can sell out for a massive gain.
Editor, Money Morning