The danger of price bias

Founder and director of investment website, Simon Brown. (Photo: Finweek)
Founder and director of investment website, Simon Brown. (Photo: Finweek)

Rather than just looking at a company’s historical share price, also consider the fundamental factors that will  potentially drive its future profits. 

Anchoring bias is when we fixate on a single piece of information to make an assessment. That is why, during a price negotiation, you should always be the first to suggest a number, because all further negotiations will anchor around the number you proposed, which you would have skewed in your favour. The price should be low if you’re buying and high if you’re selling.

For investors, anchoring bias can negatively influence their judgement. In this column, I want to focus on share prices and something I call ‘price bias’.

We have more than 100 shares on the JSE trading more than 30% below their 12-month highs, with several of them down by 80% from these highs. An investor may look at this and decide that it means a share is cheap and worth investing in. But that investor is suffering from price bias as they are fixating on the share price while missing the real story.

So, what is the real story then? It is the expected earnings of a stock over the next few years because, ultimately, this is what matters most.

Take property stock Capital & Counties as an example. The share price peaked at over R100 in late 2015 and then started this year at around R50. It is now below R30.

Focusing on just the share price, one can make an argument that the current price looks attractive; we can dream of the days when the stock returns to R50 and ultimately R100, ensuring the investor great riches.

But this ignores the reason for the price collapse and the future of the company.

The first collapse was the result of the Brexit vote in mid-2016 that saw the stock down a third in one month, and down by almost half by the end of that year. Then this year bought the pandemic and lockdown that saw the share lose another third of its value to its current levels.

Basically, the price collapse over the last five years has been driven by a collapse in the fundamentals of the stock.  Thus, rather than focusing on the price, we need to focus on the fundamentals over the next couple of years. It’s these fundamentals that will drive the price higher, not the fact that the price has been higher in the past.

Capital & Counties’ latest half-year results to the end of June show a loan- to-value (LTV) ratio of 32% and property values down by about 17% (this is around the mid-range of expectations for property value declines). On the surface the company looks alright, considering the pandemic and resultant lockdown that occurred during half of the reporting period.

However, the real concern should be that the two issues that drove the share price lower, Brexit and lockdown, are far from over and could continue to hurt the business. We also have no idea how long any recovery will be.

Furthermore, when will the recovery get us back to the pre-Brexit and pre-lockdown business activity of the company?

In other words, the focus is on the future earnings and my sense is that while we will get back to some sort of ‘normal’ in due time (albeit I think the new normal will rather be a very different new reality), it is going to take some time and more pain. And worse results will likely be experienced before we hit a bottom. Adding to the risk, especially with UK property, is that maybe even more capital will be required by the company.

So, as an investor, ignore previous price levels and certainly keep in tune with current results. Rather focus on what will drive profits in the years ahead and ask yourself how the profits will grow. Those profits will be what determines any future share price.

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This article originally appeared in the 27 August edition of finweek. You can buy and download the magazine here or subscribe to our newsletter here.
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