Beware of “Hot” Stocks

Schroders, in the Nestegg 28th Sept. publication, explain the perils of buying the latest “hot stocks”, which are typically companies operating in “sexy” sectors such as technology or healthcare with a potential reach to places like China. Mergers and acquisitions or just a very persuasive story can create further excitement regarding both established as well as new companies.

The valuations (ie share price) on these companies can be wildly optimistic, and based upon an assumption that the current profits are sustainable over the coming decades. In many cases, recent profit growth may be inflated by say, an increase in product prices which is unlikely to recur.

For example, they site the collective market capitalisation (ie market value of issued shares) of CSL, Cochlear, Resmed and Fisher & Paykel Healthcare as being $150B when revenues are $16B and and profits $4B. By comparison, Rio Tinto has a market cap of around $100B despite delivering 3 times the collective revenue and 4 times the collective profit of the former group.

You can see from the above numbers that investors are being wildly optimistic about the prospects of these “growth” companies and have paid a high price for their future profits. The margin for error is very small. Instead, they should invest in companies who share price implies sensible expectations regarding future profits.

In summary, Schroders expect financial markets to be volatile in the future and caution investors against buying the latest hot stocks and then expecting miracles. More than ever, a proper assessment of a company’s realistic prospects is vital to avoid a mishap.

Such a task is not easy but several options exist. These include using a professional fund manager (via a managed fund,listed investment company, exchange traded fund or separately managed account), to select companies or engaging an adviser who can access the high quality research required to create and manage a portfolio. The best option would depend upon the individual investor’s level of investment expertise, risk tolerance, time capacity and inclination to be involved in making investment decisions.

We would be pleased to discuss these issues without obligation.

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