Why it's dangerous to be obsessed with share prices
Some time ago, a Finance Director of a small company decided he wanted to invest some cash in his company. There is nothing notable or unusual about this. Directors buy and sell shares in the companies they work for every day.
So the director bought 12,297 shares for R9,960.57. In doing so, he pushed the quoted price of the shares up from 81c to 89c. This small company had a market cap of R172 million before this transaction. Two days later, its market cap was sitting at R190 million.
You can see what has happened here. A share trade worth no more than R10,000 was enough to boost the company's value by R18 million! It sounds incredible and, to make it even stranger this trade didn't signal in any way that the company was worth more or less than it was the week before!
Don’t read too much into the day to day share price
What did private investors in this company think when they saw the share price rise by nearly 10% after a director bought shares?
I’ll bet many of them assumed that something was going on at this company and they should buy in... Maybe something important was about to happen; maybe a big contract had been won; maybe the company’s profits were going to outperform expectations.
Some investors will have experienced a sense of panic to buy shares. They’ll have feared missing out of this opportunity and would have tried buying shares at all cost.
In this ensuing panic, the share price shot up to 100c from 89c as investors bought this illiquid penny share…
But a week later, the share was trading back at 83c… Excited investors that bought in at 100c took a 17% knock as the share merely corrected!
You see, buying just because they thought there was an opportunity was the wrong thing to do. Yet many investors take their cue from the movement of a share price. I don’t!
I use my PowA! Penny Share selection system to determine whether a company is performing as it should be and, to an extent, whether the economic climate that it faces has taken a significant turn. Although some investors pore over charts and watch every tick of a share price on their computers, these price signals can be very misleading.
You see, a director could decide to buy a boat and finance it by selling some shares. A fund manager finds that his clients are withdrawing money from his fund, forcing him to sell his favourite shares. Another fund manager decides to shift money into small companies and out of bonds, pushing the share price up.
In all cases, circumstances have dictated a purchase or sale of shares, and in the case of penny shares this can knock or boost the share price temporarily without telling us anything at all about the progress of the business.
That’s why it’s so important to look at the bigger picture. You have to know that there’s liquidity in a share. Before buying or selling you should know whether there’s enough liquidity at the price you’re targeting. And most importantly, you must know that the shares you are buying are undervalued, and the ones you are selling do not present enough value any more.
Remember: Don’t read too much from a day to day share price, up or down. Rather look at the bigger picture and you’ll always find value!