Concept Advisory Services

• Are You Gambling When Investing In Stocks?

  Posted: April 10, 2008, 7:30 pm by CRB

  I have a lot of fun following individual stocks. I keep tabs on a small handful of companies that I have a personal interest in - Centum, Kenya Re, KenGen, and Barclays Kenya, namely. I watch for news articles on the company, read their annual and quarterly reports, and stay up to date on pretty much everything about the organizations.

  For a short while, I owned individual shares in Housing Finance and Mumia’s Sugar in mid-2007. I bought into HFCK in late July, purchasing about 4,000 shares when the stock was at k’sh 38. Over the following three weeks, I watched HFCK drop like a stone to below k’sh 25, then I sat there through late August and early September as it rose back up to k’sh 40. I sold immediately. Over the same rough period, I bought 500 shares of Mumias at k’sh 32, watched them sink and struggle to rebound, and sold the shares in late September at k’sh 29.

  In the end, I didn’t lose too much money. What I did lose is a lot of sleep. The second I owned those stocks, I became obsessive over those two companies. I read every single morsel of information that came out about them, read reports, studied numbers, sweated, didn’t sleep at night, and a few times I even queued up panic sales of these stocks.

  The second I finally sold all of them, I felt much better, and I walked away with a bitter taste in my mouth. But is that the right lesson to take away from the experience? Let’s dig into the idea a bit.

  Most forms of gambling that aren’t merely chance, such as blackjack and poker, are games of partial information. You know some of the information out there - the cards you hold, perhaps some of the cards the dealer holds, any revealed cards, and the “tells” that the other players have shown you. At the same time, key pieces of information are hidden - what the others are actually holding.

  The same statement is true of stock investing, except the story is a bit different. Most of the information you’d really need to know - in fact, virtually all of it - is right out there for you to see. The only problem is that it’s like trying to find a water droplet in Lake Victoria - there’s so much information out there that processing it all is impossible.

  As a result, stock investors often choose specific pieces to focus on. Perhaps they look at the P/E ratio for a company, or maybe they look at the backgrounds of the company leaders. I’ve read tons of books about different strategies, but most of them boil down to isolating a few key pieces of information about companies and using them as a judge about when to buy and when to sell.

  The problem is that no individual metric is perfect. One can’t ever boil down the complexity of Mumias entire business into just one factor. What would happen to Equity stock if tomorrow morning James Mwangi dropped dead of a massive heart attack? Do you have any idea? Obviously, it would go down, but how far would it go down? Would Equity weather that storm? Those are both huge unknowns, but investing in Equity stock means you’re making some sort of prediction on those questions. You’re using one view of the information to make a judgement about a whole company.

  Some people respond to this glut of information and the inherent risks quite well. They focus in on specific things and just blot out everything else. They do the homework they need to do and walk away from it. Are these people gamblers?

  What about others, like myself? When I invest, I am almost driven crazy by the desire for more information. I know that there is more to know about where my money is sitting, and I need to know it. Am I an information addict?

  Personally, the risk itself doesn’t bother me so much - I am merely overwhelmed by the actual level of information in that information game. But what about a person who knows why he’s investing, but is ready to throw up after a 0.5% drop? I have a close friend like that - he basically can’t invest in anything that isn’t fully guaranteed. Is that person far too conservative?

  It all comes down to personal makeup and psychology. Some people are predisposed to play this information-rich game; others simply aren’t. I put myself into the “ average predisposed” category - I invest when I have money that is truly “play” money, but not if anything of any importance relied on that money. It would move from being a dalliance to being an obsessive information hunt - and that’s the result of my psychological makeup, not the game itself.

  Individual stock investing is something like playing blackjack at a casino where, on every hand, the dealer is wagering just a little tiny bit more than you, but there are thousands of people around you shouting out suggestions. If you can concentrate enough and take the time to sift through the information overload correctly, you can potentially go on a very nice winning streak - and the odds are slightly in your favor. At the same time, though, as with any game where you don’t have all the information, you can very easily go on a losing streak.

  My solution to all of this - and the solution that leaves me sleeping well at night - is to buy some units from the fund mangers. That’s kind of like going to that casino and playing 5,000 hands at once with earmuffs on. Because of the huge number of hands, the luck of any individual hand is negated and eventually you end up with a small overall win without the stress, time, and focus needed to win at an individual hand.

  I think investing in individual stocks is a fine diversion and a potential way to earn a lot, but far from a guarantee and the work needed to get those earnings is tremendous. For the casual investor who hasn’t invested the time to really learn the game and the investment and learned how to fight through the information noise, individual stock investing might as well be gambling.

Blah blah blah

Fish cakes

Alas a fish cake.

Yet more fish cakes

Guess what ... yeah ... fish cakes.

The end of the fish cakes