The value of an investment

We are still seeing share markets in South Africa as well as abroad rebounding from the big sell-off towards the end of 2018.

In South Africa we are now a few days away from the elections which could have a material impact on our markets and especially on our currency. As mentioned in our previous newsletter, international investors and political commentators are of the opinion that a strong result for the ANC will bolster Cyril Ramaphosa’s hand to continue with the clampdown on corruption and economic transformation, which will benefit the rand and at least support the current surge in share prices.

We have to understand that the price you pay for a share is determined by the earnings expectation for a company over the shorter term. Investors determine the price they are willing to pay for a share by taking the earnings they expect the company to generate and pay a multiple thereof for the share today. This means that, when the company issues their actual quarterly earnings report and the actual earnings are less than the investor expected them to be, the investor will adjust the price for the company downwards and sell the share at a lower price.

It may be reasonable to believe that an investor who values a share on a very short-term earnings outcome is making a mistake because the actual value of a company can take much longer than a quarter or even a year to manifest, but that is the nature of equity investing. The same knee-jerk reactions occur to things like elections or policy statements. Investors have certain expectations regarding the outcome of an election and will act immediately upon the results. We saw this happen after the ANC’s 2017 elective conference with a narrow win for Cyril Ramaphosa. The SA share markets surged, just to crash back after a few months when reality set in.

When it comes to investing we have to remember that acting on these short-term volatile movements is not prudent. The true value of any investment can take a long time to unlock and as long as we do not pay more for a company than the longer-term fundamental figures support, we do not have to get anxious about the shorter-term volatility.

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