The share price graph is one of the most used tools in company analysis. Whether consciously or sub-consciously it undoubtedly always plays a part. Ask yourself if you’ve ever thought or heard someone use these phrases:
“The share price has rallied hard this month so we’ve missed out” or,
“The share price has doubled this year so it must be a good business”, or
“The share price has seen steady decline all year so I wouldn’t touch it with a 10 foot pole”.
While these very real situations may all be triggers to begin looking into a company, it should never be the driving force of an investment decision.
A company that has risen all year may continue to increase earnings and therefore could be cheap. Alternatively, perhaps the share price has increased more on sentiment than earnings and therefore is very expensive. And in the case of a sudden drop, perhaps it has been oversold and now represents good value.
You can’t know until you’ve conducted an analysis on the company fundamentals and created a valuation.
The share price chart gives you every price the stock has traded at over a given period of time. The only price that’s meaningful is today’s price. That’s because today’s price is the price at which the market is currently valuing the company. It is your job to work out whether the market is wrong, why it’s wrong, and act accordingly.
The other reason to use share price charts sparingly is that they can often give very different representations of the business depending on the time frame. Take Lovisa (ASX:LOV) for example. Here is the graph for the last 12 months.
Here is the 24 month chart:Stellar performance, no? This chart tells you that the company has had a very good year, but tells you nothing about its earnings or valuation.
Whoa. What happened last January? The stock has only just recovered!
The point I’m trying to make is that the 12 month graph hides any medium term performance and paints a starkly different picture.
One company. Two charts. Two different stories.
Not only does a chart give little information about the actual performance of the business, it can also skew your thinking. You might see an increasing share price and assume in your mind this is a good company, which could subconsciously influence your evaluation of the company and ultimate investment decision. The inverse is also true.
Warren Buffett doesn’t like to look at share price graphs. His view is that he only buys a company where he wouldn’t have a problem if the stock didn’t trade for 10 years. This comes back to thinking about stocks as businesses, not just a ticker on a page. Buy a share in a business where you believe it can continually provide cash flows in the future, not because you think the market will send the price higher in 6 months. Consider yourself a part owner of the business, because you are.
So by all means, use the company’s share price movement as a trigger to investigate, but this should only be the first step of many in determining the future earnings prospects of the business in relation to its valuation.
Farnam holds Lovisa in the Value Portfolio.
This document has been prepared by Farnam Investment Management Pty Ltd (Farnam) ABN 15 149 971 808 AFS Licence 430574. Australian Unity Funds Management Limited ABN 60 071 497 115 AFS Licence 234454 is the responsible entity of Farnam Managed Accounts. While every care has been taken in the preparation of this document it does not contain any recommendations to buy or sell any particular stock(s) noted. Farnam makes no representation or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. The information in this document is general information only and is not based on the objectives, financial situation and needs of any particular investor. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek their own professional advice. Past performance is not a reliable indicator of future performance. The information provided in the document is current as the time of publication.