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Investment Tips

Understanding Investment Bias: What influences investors’ decisions?

The benefit of behavioural finance is that investors are able to recognize these behavioural biases and take corrective actions to avoid financial losses.

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When an investor buys or sells a security, is that decision based on a knowledge of all the relevant information about that asset? Probably not. Most financial decisions are made based on irrational or insufficient analysis of data, thus leading to irrationality. Irrationality is a product of our own behavioural bias.

Behavioural Finance combines behavioural and cognitive psychology theory with conventional economics and finance theories to provide explanations for why people make irrational financial decisions. The benefit of behavioural finance is that investors are able to recognize these behavioural biases and take corrective actions to avoid financial losses.

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I have selected just a sample of some behavioural bias:

  1. Anchoring
  2. Herding
  3. Familiarity
  4. Trend Chasing
  5. Loss Aversion

Anchoring: An Anchor bias is any variable of information which has no direct relevance to a decision but does affect financial decision making. In essence, a bit of information becomes “anchored” in our minds and thus automates our decision making.

An anchor can establish a low price bias to encourage a purchase decision or establish a higher price to lock in future purchases on that price. For example, a phone is listed at N20,000 but the shop puts up a “10% Sale” sign beside the price, effectively “reducing the price to N18,000. The buyer, however, anchors in his mind that the phone costs N20,000 not N18,000, he assumes a N2000 “discount” and pays for it. If given a choice between this phone and a similar model costing 18,000, a buyer may select his phone believing a deal of N2,000 for a N20,000 phone.

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[Read Also: Important tips on how to profit in a bearish market]

Another excellent example is when a stock priced at N50.00 falls to N20.00.  An investor, having anchored the previous N50 share price in his mind, will determine that N20 is a “cheap” price and invest in that stock.

Key lessons: Do careful intrinsic evaluations before investing. For the entrepreneur, Be careful when setting prices. If your “special” pepper-soup, for instance, is  N2,000 per plate, that’s the anchor. Customers will be wary about paying above that prices for any other dish in your restaurant.

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Herding: Herding Bias is the tendency for individuals to copy and follow the actions (rational or irrational) of a larger group.

Imagine you go to a party and everyone is talking about this cryptocurrency fund they have just invested in. You are normally risk-averse, but you reason in your mind that if so many people are investing in this cryptocurrency, they all cannot be wrong. Consequently, you take comfort in the “safety” of crowds and also invest.

With herding, any form of appraisal is blurred by the tendency to follow the crowd, and not be left out of the latest investment trend.  In other words, herding diminishes analytical reasoning, and that is the danger.

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Key lessons: Study each investment carefully on its own merits and always remember every investor has different levels of risk acceptance. Referrals are just that…referrals to you. Ensure you do your own due diligence all the time. If everyone speaks highly of a vendor, have your own in-house assessment to confirm if the internal process of that vendor is aligned with your organisation. Do not just hire an Insurance company because everyone in your industry uses them; have your own internal decision-making process to select vendors.

Familiarity:  Familiarity bias is when an investor has become familiar with the operations and/or returns associated with a particular asset class, develops a comfort zone around that asset class, and is then reluctant to try other asset classes even though they may offer higher returns or reduce the overall risk of the portfolio. Here is an example; an investor may only be aware of investing in two-year Corporate Bond which he rolls over continuously after earning interest. Coupon bonds become his investment comfort zone and he is reluctant to invest in a security that pays zero interest such as a zero coupon bond, even though that security with no coupon payments is less susceptible to interest rate movements, thus less risky.

Key Lessons: Invest with a goal in mind. If your investment goal is clear and properly communicated, then follow the guidance and advise of an investment professional. Scenario planning, explore multiple options on paper, to see the effects of each action, before taking a decision.

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Trend-chasing: This is when investors look at the past performance of a security or company in order to make a decision today whether they should invest.

In the world of investing, the common maxim is “Past performance is not a guarantee of future performance”. A fund may return 40% in year 1, even as a 43% return in year 2 does not mean it will even break even in year three.

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[Read Also: Here are ways to ask family and friends to fund your business – PART 2 ]

Trend-chasing is a very common bias because investment firm will advertise their past performance to attract prospective new investors.  Even if the investment firm is honest and competent and really wants to deliver above average returns, the fact that other investment firms will copy a winning strategy means the impact of that winning strategy will be greatly diminished.

Key Lesson: When evaluating investments or investment firms, employ quantitative and non-quantitative measurements. Take past performance into account, but do not base decisions solely on that factor. Look at every investment on its merits, not its antecedents. Past performance and prices are not a sufficient indication of future performance or prices.

Loss Aversion: Loss aversion bias is when an investor has an aversion to making or admitting they have made a loss on an investment.

Investors have a high degree of confidence in their ability to pick investments, and do not want to admit that sometimes they picked the wrong horse. The direct implication is that investors hold onto a bad investment, because selling that investment will acknowledge to themselves, they made a mistake.

For example, MMM, the failed ponzi scheme, attracted a lot of deposits. Some “investors” may have run the numbers and determined the scheme was unsustainable. Yet, they still did not exit the scheme. Another example is Bitcoin; as the prices crashed, many held on to their cryptocurrencies unwilling to admit they have bought at the peak of the curve.

[Read Also: Unilever Nigeria Plc announces close period ahead of Q3 2019 results ]

Key Lesson: The way to avoid loss aversion is to have a clearly defined exit strategy. Be clear on what will trigger a sale from your portfolio. Also, do extensive research before investing

Summary: It is important to recognise that investors are humans and bias will always seep into all decision making; including financial decisions. The way to avoid bias, however, is to have a plan/strategy to invest and manage a portfolio, including agreeing to an asset allocation strategy and retaining a competent financial adviser.

Artificial intelligence financial programmes are also helpful in stripping away bias.

Patricia
1 Comment

1 Comment

  1. Charles

    May 14, 2019 at 8:10 am

    So much enlightenment in a brief…

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Investment Tips

What bad stocks have in common with bitter relationships 

The feeling you get from marrying the wrong partner is similar to that felt after buying the wrong stocks.

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I have always argued that stocks cannot be summarised into one statement for a newbie, until recently when a friend told me that it could.  

“Simply put, buying stocks can be likened to relationships, he said.  

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did not immediately agreebut over the next few minutes, he explained to me what he meant, and drew several analogies to back his claims.  

While he is no expert, I understand that he has drawn his conclusion from his experience buying stocks for himself over the past 5 years, so I took his points seriously. These points have been summarised in this article. 

READ MORE: Cocoa prices melt lower as COVID-19 weakens demand 

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When it crashes, there is no telling how far it can go  

My friend mentioned of some company’s stock he bought in 2016 in the hope of selling short-term. At the time he bought, there was a dip and he expected things to pick up within some months so he could sell-off.  

Two years later, the stock price had plummeted 50% down from the price at which he bought. Without saying, he became a long-term investor because he was not ready to sell off at a loss.  

 

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How does this liken to being in a bad relationship?

As the value plummets, you keep hoping it will rise again and then before you know it you are stuck for the long haul. Same thing can happen with a wrong partner. You remain there hoping things will be better but it gets worse. 

It could happen sometimes that a company’s stock market price comes crashing and it never goes back to where it was againThe factors which triggered its fall, may not even be able to return it to its starting price.  

 

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The stock price is not indicative of the company’s profitability 

For some reason, there are company stocks market prices that remain low year after year despite the billions declared in profits, and the dividends paid out to shareholders.  

Sometimes, the stock market price could still slump even when the company has positive records in its financials. Market experts are not always able to explain this, but it remains true. Some of the most profitable stocks are undervalued.  

 

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You can never take stocks at face value

That a stock has been on an upward trend in the last few months does not mean it will remain so. One must always consider several other factors before purchasing a stock.  

While it is important to look at past performance, there are other things that could point to the likely future of such stocks. 

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Say, for instance, the company has just announced a new board chairman who was implicated in some fraud cases in the past. It doesn’t matter how well the stocks have performed in the last 365 days, or the chairman’s competence, the stock prices are most likely to slump due to loss of investor confidence.  

There was a recent case where the CEO of an internet service provider company was alleged to have been involved in sexual harassment, and was eventually pressured by shareholders to resign. The pressure came not necessarily because they thought he was guilty, but because of the implications on the company.  

You have to probe to discover the real qualities.  

 

The most expensive stocks are not necessarily the best. 

If you ever heard a stock described as under-priced or over-valued, then you should understand that the price you pay is not necessarily suggestive of the value.  

Some great stocks, with good potentials, high liquidity, good company profile and adherence to corporate governance ethics, are not as expensive as they should be. While some other stocks are ridiculously overpriced, even when they do not have as much promise. Some of these overpriced stocks could still be basking in past glory or just positive media hype.  

This explains why investors must conduct due diligence before putting in their hard-earned money. Sometimes the media hype around a company’s stock might not be giving you all the information you need to make a decision, so you necessarily have to go the extra mile.  

Subscribe to newsletters from financial news websites if you need to, take courses if you have to, but ensure to learn all you can.  

Remember price is what you pay for the stock, but value is what it is really worth, and there is no law stating that one must justify the other.  

READ MORE: Global stocks records astronomical gains in Q2 2020

When you get the wrong stocks, you get stuck! 

You know that feeling when you are sure that you have made the wrong choice, but also know that there is no way out? That’s the feeling you get when you marry the wrong partner, as my friend said. And that’s the same feeling you get when you get the wrong stocks.  

You simply get stuck.  

No returns. No dividends. Probably, no way to sell either because no one else is interested in buying from you. And if you do succeed in selling off at this point, you would most likely be doing so at a loss.  

If you study trends in the stock market, you will see some dormant stocks that have remained stagnant for long periods of time. No rise in share price, no fall in share price, and no share is being traded either.  

READ ALSO: Best time to make money trading BTCs

It is not a nice position to be in, and that is why you want to be sure of the company, its management, and board members who take the decisions before you decide to buy or not, even more so when you are a long-term investor.  

And even then, with the wrong stocks, you could suddenly find that your proposed short term investment of 6 months will run into years because you keep waiting for things to pick up before you sell.  

Patricia
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Investment Tips

Where to invest using PE, PEG

Investors should always look at the sector P.E. and compare that with individual stock P.E.

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Uncertainty strengthened as foreign portfolio investors pull out funds, chess board

Assuming, you the investor is interested in buying shares in the banking space, you have about 100,000 to invest and you want to buy the best stock that will give you the greatest return at the lowest price. You have two banks in your investment universe; you prefer Bank A and Bank Z. Bank A sells each share for N10 and Bank Z sell each for N5

Table 1.

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Share Market Price N:K
Bank A 10.00
Bank Z 5:00

 

Which would you buy? Well that easy, I would buy Bank A why? because it is cheaper. With N100,000 I can buy more shares of Bank A than Bank Z.

Hold on, not so fast.

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The market price of any stock relates to the expected future earnings of that stock. For instance, Bank A’s share price of N10 means the Present Value of the sum of expected earnings that will accrue to Bank A over the life of earnings is N10. Hence you cannot simply compare the price of Bank A to the price of Bank Z, you must compare Earnings of both banks to determine which is “cheaper”.

READ MORE: Access Bank Plc reports profit of N40.9 billion for Q1 2020

So, to compare earnings, we use a ratio called the Price to Earnings Ratio (P.E.). Earning here is the earnings per share, which means we divide total earning by issued shares. Again, we assume a total of 1m shares issued by both banks. To calculate PE, first get earnings per share, so if bank A posted earnings of 1,000,000, and we have issued shares of 100,000 then Earnings per Share is (1,000,000/100,000) or 10. The P.E. for Bank A would be (10/10) or 1.  A P.E. of 1 means the share price is 1 times the earnings of Bank A, very good. (lower P.E. is preferred). Let’s also assume Bank Z has a P.E of 0.5

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Now if we look at table 2 which now compares prices to earnings, we can see the PE of Bank Z is lower than the PE of Bank A. This means Bank at price of 10 is trading at 1 times its earnings when compared to Bank Z which is trading at o,5 its earning, thus we can say that Bank Z is “cheaper” than Bank A because we are buying at a lower multiple of earnings

Table 2.

Share Market Price N:K P.E. Ratio
Bank A 10 1
Bank Z 5 0.5

 

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READ MORE: Nigerian Stock market records sixth consecutive losses, investors lose N15.55 billion

We can also say that if a company has a high price relative to her earnings, then that company is a Growth Stock.  If, however the price relative to the earnings is lower, then the stock is a Value stock. A high growth sector like IT or biotech will have a faster growth and relatively higher PE ratio than a company in the utility sector with predictable steady earnings growth. Investors should always look at the sector P.E. and compare that with individual stock P.E.

P.E. is known as a trailing ratio because it is based on the past. Company can give forward guidance on earnings and that is used to create a Forward PE ratio. What if we wanted to compare both banks but this time instead of looking at past earning, we want to investigate the future and ask which bank we should buy using expected earnings as our main guide. To do this, we have to input expected earnings into the mix

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Let us assume Bank A is buying a smaller bank, and that will give her more branches, leading to higher growth in the future. Let’s say this will; lead to a 20% growth in earning year by year. Bank Z is not as aggressive and earning will increase, only 10% does this change the current recommendation?

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It does and it introduces us to another ratio called the Price to Earnings Growth Ratio (PEG). The PEG is the P.E. of the Stock of the company divided by the growth rate of its earnings. We have already calculated the P.E. Ratio, so the PEG for Bank A is (1/20) or .05. This is an exceptionally good measure indicating the stock is undervalued. A PEG less than 1 generally means undervalued, more than 1 means overvalue

Patricia
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Top AgriTech deals currently on sale in Nigeria – June 2020

These options were picked from firms known to insure their farms and farm produce.

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Agricultural financing, Top AgriTech deals currently on sale in Nigeria – June 2020

The month of June is coming to an end, but just before it does, Nairametrics is bringing you Agritech deals you should consider investing in. Ordinarily, this is not the best time for AgriTech investments, as the rains have started and most farmers are done planting.

However, there are still some late planting to be done, so this means there are some late deals you can take advantage of. From the details of these deals, you will discover those meant for funds you intend to keep long-term and those for the short-term.

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These options were picked from firms known to insure their farms and farm produce. There are some AgriTech firms that should also be in this list, but this list only captured those which had deals open for sponsors and investors as at the time of writing.

Thrive Agric is quite popular in the Agritech space but as at the time of writing it, there was no farm deal open for sponsorship.

Wealth.ng also has a couple of agricultural investment options, but they have been completely subscribed by the start of June. Only real estate investments and stock options are open.

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READ MORE: The Different Dimensions of Investing in Agro-Tech

Farmcrowdy usually offers a variety of investment options, from maize farms to rice, potatoes, fish, cassava, poultry, cattle, but most of these options have been sold out and closed, after full subscription. Its farms located in Kaduna, Oyo, Ogun, Niger and Lagos states are all insured by Leadway Assurance.

Top AgriTech deals currently on sale in Nigeria – June 2020

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Only one option is still available from Farmcrowdy as at the time of writing.

The Farmcrowdy food gives 10% Return on Investment (ROI) per annum with the minimum holding period of 7 months. The minimum investment is N20,000 being for the sponsorship of one farming unit.

At this rate, an investment of N100,000 would yield another N10,000 by the end of 7 months.

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This investment funds covers the cost of production of several farm produce like potatoes, vegetables, and staple foods, and the farms are located in Lagos state.

Another deal you could consider is the Fish farm investment with Groupfarma. This investment gives 27% ROI. A unit of the fish farm investment can be sponsored at N52,000, and the Oyo based farm runs a nine-month farming cycle. The farm is insured with the Nigerian Agricultural Insurance Corporation (NAIC).


Farmkart also offers a fish farm option but with different terms. You need N100,000 to purchase a unit of this option, with 15% ROI over a period of a 6-month farm cycle. The investment funds cover the farm inputs, the pond rents, organic supplements, payment for the farm workers, insurance and the farm is located in Ijebu-Ode, Ogun state.

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With the Groupfarma option, every N100,000 invested in the fish farm will yield N27,000 at the end of the 9-month cycle, while the same investment with Farmkart will give you a yield of N15,000 in 6 months.

READ MORE: Pig farming is a goldmine in Nigeria- Porkmoney boss

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The choice of investment here would be determined by how long you want the funds to be held.

Top AgriTech deals currently on sale in Nigeria – June 2020

The Federal Government had complained of the millions spent on importation of fish into the country. Worse still, Nigeria has been tagged the largest importer of fish and fishery products in Africa and the world’s fourth largest in volume terms (5.4% of global imports) after China, Japan and the US.

What these figures tell you is that any investment towards improving the aquaculture industry and fish production, has a profitable value chain. So, you might want to consider it among your options.


Payfarmer also offers a Catfish Farms investment where investors can sponsor a unit with N50,000 and expect 20% ROI after the farm cycle of 7 months. This means that N100,000 investment will grow to become N120,000 in 7 months.  The farm is located in Epe, Lagos state.

Payfarmer has a couple other investment options still open as well.

The Payfarmer Pepper Farm investments opens at a unit entry of N25,000 investments and you get 12% returns with a minimum holding duration of 5 months. An investment of N100,000 here would give you additional N12,000, and if you are looking for an investment that frees up your funds just before the yuletide, then this would be a good option to consider. The pepper farm is located in Epe, Lagos.

Payfarmer also has several Pig farm options. The first requires a minimum investment of N5 million naira for a unit and gives you 34% returns with a minimum holding period of 10 months. This means one-unit investment here will yield of N1.7 million at the end of 10 months.

READ MORE: Invest and earn 300%: How scammers came after me

There is also another Pig farm option which allows an entry investment of N250,000 for a unit, giving you 28% ROI in 10 months. Every N1 million invested in this farm will earn a profit of N280,000 at the end of the cycle.

Top AgriTech deals currently on sale in Nigeria – June 2020

The third Pig farm option has a unit investment of N500,000 with a 30% return and a 10 months farm cycle. An investment of N1 million here earns N300,000 at the end of 10 months.

The fourth Pig Farm option allows a minimum of N1 million for a unit and gives you 32% returns in 10 months.

All of these pig farms are located in Epe Lagos. Again, it comes down to the investor’s choice and availability of funds.


Farmfunded is another popular name in the space and even though most of its plans are sold out, there is one still open.

The integrated rice mill financing offers impressive returns but, it is strictly for investors who have funds to hold in the long-term. Because the company is trying to increase rice production capacity in Nigeria all investments have to be held for a minimum period of 24 months at the end of which the investors get 80% returns.

To make things easier, the investor may or may not cash out his 10% returns every quarter (3 months) but will not have access to the capital until after 24 months. This ensures that the farms have a stable capital base to grow and expand over the next 2 years. The thousands of acres of land to be used for these are located in Kano State Nigeria.

READ MORE: KIAKIA Peer-to-Peer lending investment app (Review)

If you have N100,000 to purchase a unit, and you decide to wait till the end of the 24 months period, you would be receiving a profit of N80,000 and a total of N180,000.  The profit is not compound, so even if you don’t take your profit, it does not form a part of your investment.

The farm is located in Kano state and allows investors to provide funds which will be committed into the procurement of milling machine, and processing of paddy rice to premium parboiled rice. Considering the gap between local production and actual demand for rice, this looks like a solid investment plan.

The company has also sought to protect its base by ensuring that investors may cash out their profits, but not the base investment, so that it can be ploughed in again for the next cycle.

Note, however, that whatever your choice of investment, you should consider the holding period as against when you would need to liquidate your investments. The crux of the deals offered is to engage your idle funds and help them grow while you continue your hustle.

On SEC: Last May, The Securities and Exchange Commission (SEC) proposed a new set of rules that will regulate crowdfunding businesses and deepen the capital market in Nigeria. This includes AgriTech firms like those listed above. The commission plans to regulate the crowdfunding business in Nigeria in order to reduce the risks associated with it for investors and financiers.

Disclaimer: This is not an investment advice or guide as Nairametrics is not affiliated to and cannot vouch for any of the AgriTech firms listed above. Kindly do your due diligence before investing.

 

Patricia
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