VALUE INVESTING
Why Buy Shares?

By Stephen Bland (TMFPyad)
June 18, 2004

'Why buy shares?' is perhaps an odd question for me to pose given that I write on the subject regularly, both here and in my newsletter. Despite that, I think the question deserves some consideration and the first points to consider are the alternatives to shares for those with money to invest.

There are two major alternatives to equities. The first and most common is cash, keeping your money in a deposit account with a bank or National Savings etc. The second for those a bit more ambitious is property.

There is one crucial and obvious difference between cash on the one hand and shares and property on the other. Cash involves no risk to capital whilst the latter two do present that risk. It follows that an investor unwilling to take any capital risk will stick with cash and this is in practice what happens with a large part of the public. Although interest rates will fluctuate, the capital is secure and consequently I'd say there is quite a lot to be said for cash.

But let's assume that an investor has some money and is willing to consider the risk alternatives of shares or investment property. Which should they choose?

Property has clearly been an outstanding investment for many people, beating both cash and the stock market index in recent years. It can though involve considerable risk because few people can buy a portfolio of investment properties. And not everyone fancies having additional substantial debt or becoming a landlord. But for those willing to go through with all the hassles, they will in most cases have been rewarded handsomely.

Shares in general are another matter completely. In my opinion, few people ever make good long-term profits from the stock market. Those that do, cannot compare in number with those who have scored in property.  It's only anecdotal but I know many more people who have made substantial money from property than who have done from shares. I suspect readers of this column will be able to make a similar observation.

So why buy shares in preference to property?

To some extent this is a personality thing. People should only invest where they instinctively feel comfortable and more than once have I heard property investors talk about the satisfaction of owning a tangible investment which they in consequence trust more than the intangible nature of equities. On the other hand, equity investors enjoy far greater liquidity and the ability to build up a risk spreading portfolio much wider than a small investor in property could achieve.

Gearing is another major factor. The availability of mortgages for investment properties these days makes them relatively easy to acquire. But moneylenders don't promote loans for equity portfolio acquisition nor would most share investors find that desirable. Somehow it seems far more risky to have a loan on a share portfolio than on a property.

If you are considering shares or property as alternatives and have satisfied yourself about the differences in hassles and risk etc. so that your only remaining consideration is the likely return, my view is that shares are more attractive only if you have a specialised strategy that is likely to deliver substantially higher returns than the market. Otherwise I would stick with property.

Contrary to what many believe, I don't think the stock market is a rewarding place compared with property. Sometimes it delivers only modest returns, frequently not much higher than risk-free cash, and there can be lengthy periods of poor or negative returns. Over the last five years for example, a tracker fund would now be down around 14% and that includes reinvested income.

The stock market strategy I follow is value - cheap shares with prospects - and it is one that I have found to be particularly rewarding over the long term. Those investors who have made decent money out of the market long term will largely be value investors of some kind. The approach is not for everyone, in practice it is suited only to a small minority of investors because it requires a certain personality in order to stick with it and of course it involves risks.

To do much better than the market you have to do something very different to the market. This means taking on the risk that you won't in the event do better than it, and may do a lot worse. In this sense, value investing differs from property in that you could have bought almost any property in my home town -  London - and done pretty well. You could have done even better by using the value approach, that is by buying in an area that changed character upwards for example, but you did not need to do so in order to make great gains.

The stock market though is a little more complex than London property. Not just any share, nor buying the whole market, will suffice. You need that strategy.

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