Investing in stocks solely based on their surge in stock price or past performance is a contentious strategy that often raises questions about its viability and wisdom. It is not a poor choice to filter out stocks for investment consideration based on price surges, but the main question remains: which stocks should one consider?
There are many instances where investors attempt to purchase stocks trading at their all-time lows, anticipating they will become multi-baggers soon. However, many of these stocks lack a sound business foundation, and even if they do, they might be struggling operationally or embroiled in litigation. One crucial point to understand is that a stock’s value is not solely determined by its current price movement.
Buying stocks merely due to their recent price surge without a comprehensive analysis of the underlying fundamentals could be a risky endeavor. This is especially true for companies that are financially weak or are trading at their lowest points. Such companies might appear as potential bargains due to their low prices, but they often carry inherent risks and may not have solid financial foundations to support long-term growth.
It’s essential to note that the stock market’s unpredictability can sometimes lead to rare instances where certain companies out of a multitude might become multi-baggers. However, banking solely on these rare occurrences without considering the broader picture and thorough analysis can be perilous for investors.
Evaluate these factors before buying shares
- Fundamental Analysis: Assessing the company’s financial health involves evaluating revenue trends, profitability, debt levels, and cash flow. A strong financial position is crucial for sustained growth. When investing, remember that you’re not merely buying shares but also acquiring a part ownership in the company. Everyone desires to see the company grow, but growth stems from a sound financial background, enabling investments in assets that generate wealth for shareholders.
- Business Prospects: Understanding the company’s business model, competitive edge, market potential, and future growth prospects is pivotal in determining where to invest. This analysis helps in realizing whether the price paid for the shares aligns with the company’s potential.
- Valuation: Various metrics are available to value a company or business. Analysing valuation metrics such as the Price-to-Earnings (P/E) ratio, Price-to-Book (P/B) ratio, and other relevant benchmarks assists in ascertaining if a stock is undervalued or overvalued. Additionally, common parameters like Sales growth, profit growth, EPS growth, ROCE, and ROE aid in shortlisting companies for investment consideration.
Read: ROE Vs ROCE
- Industry Outlook: Considering the industry’s overall performance, trends, and potential disruptions is crucial. Government initiatives can significantly support particular sectors, presenting sizable investment opportunities.
- Risk Management: Diversifying your portfolio helps spread risk, avoiding excessive reliance on a single stock or sector. Avoid investing all your money in a single stock without thorough research solely because of its increasing price. Investing out of FOMO (Fear of Missing Out) might lead to regrets when the price declines. It’s crucial to conduct comprehensive research before making investment decisions.
Buying Shares is Buying Ownership
Investors should remember that buying shares means purchasing ownership in a company. A company’s weak financial standing could lead to capital erosion, jeopardizing the investment’s value. Hence, it’s prudent not to solely rely on recent stock price movements.
While there might be occasions where tracking stock price movements can be advantageous, such as identifying undervalued stocks or entry/exit points, it should not be the sole criteria for investment decisions. Instead, a balanced approach combining both fundamental and technical analysis is advisable.
Read: Fundamental Analysis vs Technical Analysis
When should you consider price movement?
Relying solely on price movement for investment decisions is possible, but it requires certain fundamental prerequisites in the company you plan to invest in. The company should demonstrate ethical practices, possess robust financials, hold a leadership position in its industry, maintain a substantial market share, feature a unique business model, and, most importantly, boast an experienced and ethical management team dedicated to the business. After thoroughly evaluating these factors, investors can consider buying based on the observed price movement and behavior.
Conclusion
In conclusion, investing solely based on recent stock price surges or poor financials of companies trading at lifetime lows can be a precarious strategy. Numerous instances exist where investors have purchased stocks due to a price surge, only to find themselves trapped as the stock plummeted, often experiencing a decline of nearly 90% from the buying price.
A thorough understanding of the company’s fundamentals, careful analysis, and a long-term perspective are crucial for making informed investment decisions. Always remember, that successful investing is about the quality of investments rather than mere price movements, and it’s the careful evaluation that separates successful investments from potential pitfalls in the market.
