Don’t let greed and fear inform your stock investment choices

Investment brokers at the Nairobi Securities Exchange (NSE) in Nairobi. PHOTO | FILE 

By SAMUEL GICHOHI

In Summary

• Sophisticated investors ignore the noise and concentrate on the intrinsic value of an asset.

As we grapple with the current bear market at the Nairobi Securities Exchange (NSE), most investors may be inclined to succumb to panic selling and avoid investing, to their own disadvantage in the medium to long term.

The end may not be in clear sight but to value investors, the opportunity to buy great stocks on the cheap is enormous.

Humans are creatures of habit and as a rule we gravitate towards what we feel or perceive to be the safest environment for survival. This situation is replicated in investment habits as we rely on the laws of probability to make our choices.

We are thus prone to following trends when making these decisions since in our psyche we are programmed to assume that the herd is probably right.

For this reason we say that, “Bull markets feed on themselves” eventually creating euphoria and, “Bears feed on themselves” eventually fuelling panic.

Bull markets fuel greed. Investors act on price action rather than value, which builds up to euphoric proportions culminating in market bubbles.

These bubbles are recognisable when valuation metrics overtake fundamental growth projections, market indices keep hitting new record highs and investor sentiment is at its highest. It isn’t surprising that in bullish times, public issues abound.

Most market corrections happen soon after record initial public offerings like Safaricom in 2008, AT&T in 2001, Microsoft in 1986 and Alibaba Group in 2014.

Fear on the other hand is the result of the underlying risk that stocks represent.

Chinese symbols depicting risk stand for danger and opportunity, referred to as the risk versus return tradeoff in finance. Simply stated the higher the risk the higher the probable returns.

A classic example is how frontier markets like the NSE are considered more risky by investors from more developed markets like the US and UK. They would only be attracted to invest here if the potential returns outweigh the underlying risk.

Even “risk free” securities like US Treasury Bills yield 0.26 per cent while the Central Bank of Kenya’s 90-day T-Bills is currently yielding 11.343 per cent, a clear indication of how underlying risk is priced into securities.

Digging deeper into fear you will find a more psychological aspect of how it works. Ask any investor what they fear most when investing and the most forthcoming answer is “to lose money.”

Yet a closer look at investment patterns indicates that most investors tend to buy into stocks when they are overpriced and avoid trading towards the tail end of a bear market, like now when opportunity abounds.

This points to “fear of losing out” rather than fear of losing