VALUE INVESTING
Buying Shares On The Rise

By Stephen Bland (TMFPyad)
June 20, 2003

A few weeks ago, I wrote an article on the relevance of the purchase price to sell decisions. My main point was that value investors should try to break the link in their mind between the price they paid for a share and the current price at which they may be considering selling. The sell decision should be determined principally by whether the share still retains sufficient value at the current price to justify a continued hold. It should not matter what was paid or how much profit or loss has accrued.

This week I will take the price question a little further. Not in how it influences sell decisions but in how far it should influence buy decisions.

What I have in mind is the situation where a value investor finds an attractive share but then discovers that the price has already risen substantially over a recent period. Some value investors find this to be a highly negative point, reasoning that the share may have run out of steam and that in consequence there may not be much more in it, no matter how attractive the fundamentals. This is entirely wrong thinking in my view. It is just fear but fear without foundation.

Share prices don't have steam. They don't have memories or foresight either. There is no connection in the short term between the price of a share at any moment and its price at the next moment, it is random. There is a connection in the long run but this is purely fundamentally based. Attempts to divine highly meaningful predictions from price movements alone are doomed to failure simply because they are random in the short term and fundamental in the long term.

Moreover, the share does not care about its earlier price, nor what it will be in the future. As a value investor you should care, but just about the share's current price once you own it. That's because you should be monitoring the fundamentals plus other factors with an eye to selling, not because the price alone has any meaning.

The price at any juncture is simply the balancing point at which the supply and demand are prepared to do business. For a potential value investor either the share represents sufficient value at that moment or it does not. I cannot see that an earlier price has much relevance at all, annoying as it may be to have missed out on a good rise. That's the way it works, nobody gets in at the bottom every time, not even value investors who will get in at a pretty low point in a share's fortunes.

You are not trying to get in at an absolute bottom, merely at a fairly low point in order that you may be able to trade the share at a good profit. There is no reason that a good value share, having already risen before being bought, should not go on to deliver that profit even though fear may suggest that an earlier price rise makes this less likely. It does not.

So in the same way as in my earlier article, where I advocated that people should not associate the current potential selling price of a share they own with the purchase price, they should not associate the current potential buying price of a share that looks attractive with what that price was in the past.

Very short-term share price movement is essentially random, though as time goes on the random movements will tend to oscillate around a path that follows the fundamentals. People are irrational to some extent which explains the former, but not wholly so which explains the latter. It is precisely because price changes are random in the shorter term that there is no link between short-term price movements and consequently it matters not what the price was earlier, if you like a value share.

By "short term" used above, I am referring to a period in which there is no known change in the fundamentals, usually up to six months between results, though it can often be less if there is some news meanwhile. Even if it is more than six months, so that some results have been published, these may not make much difference to the fundamentals. So, in the absence of news about a share, any price movement cannot be fundamentally based and hence will be what I have called irrational and random.

Ultimately, very deep value will out one way or another which is not the same as saying it always wins. Sometimes the fundamentals worsen or remain static instead of demonstrating the anticipated improvement. But if it doesn't win, it is not likely to be because you bought after a rise had already occurred.