False profits

Thursday 1st November 2001

Roger Armstrong asks, are Kiwi investors stupid or just misguided?

My mate Steve the sharebroker has spent the last few months warding off kamikaze clients hell-bent on skewering themselves on Air New Zealand shares.

Why, he lamented, are New Zealand investors so stupid?

But "stupid" doesn't adequately describe the number of ways that New Zealand investors conspire to lose money on financial markets. Why is this so? Why, as a nation, do we collectively invest so badly?

My pet theory is that we suffer from being raised in a very safe society ("New Zealand, a great place to bring up kids") where we are not used to watching out for sharks and charlatans. Consequently, we are too trusting. We believe what we see in the media, we read prospectuses with a positive rather than a cynical eye, and we buy from anyone with a silken sales pitch.

And we are greedy, expecting to double our money rather than make the 10%-5% returns a year one should rationally expect from the sharemarket. This leads to risk-taking and a subconscious desire to believe the big talkers who seem to inhabit many of our public companies.

We are speculating (badly) rather than investing. Mind you, our individuals are no worse than our corporates, who invest equally poorly, especially when making acquisitions overseas (see "Aussie buggers").

Let me count the mistakes New Zealand investors typically make:

Buying Air New Zealand et al

I presume my mate's clients were so keen to buy Air New Zealand because it was a strong brand that they believed "must" recover. But its loss on buying (and closing) Ansett is permanent. Having let Ansett go there is no chance of ever recovering the $1.3 billion invested. And worse, the World Trade Center disaster is the largest shock the airline industry has ever received. But still, the optimistic punters bought, believing in an unlikely recovery rather than the reality of further misery.

Hero worshippers

Everyone else around the world has forgotten about the 1987 crash, but it still looms large in New Zealanders' memories. Our sharemarket index stands at around 1800, compared with 3900 in 1987.

Pre-1987 our market was full of investment companies. The average private investor's portfolio consisted of Chase Corporation, Ariadne, Judge Corporation, Brierley Investments, Equiticorp and Robert Jones Investments. All hero stocks - companies run by high-profile figures who milked the media and came to be seen as gurus.

From heroes to zeros, most of them, which is why investors and the market took such a permanent hiding from the 1987 sharemarket crash.

This hero worship did not die out with the 1987 crash. A couple of years ago many followed Eric Watson into every one of his sharemarket plays - no matter how improbable, no matter what cost advantage Watson procured for himself on entry versus the punters. Advantage, where Watson probably entered at 30–40 cents, peaked at $5 and is now around 30 cents again. Eldercare went from 70 cents to 12 cents. Strathmore from 60 cents to 6 cents.

The punters' latest hero is Howard Paterson, who has successfully launched A2 Corporation (on the informal "grey" market) and BLIS Technologies. It's too early to tell if Paterson will produce Microsofts or Equiticorps - certainly initial investors have made great gains. But it seems the punters have now gone crazy over Paterson, dropping the cynical eye that is essential with any relatively untested stock.

His latest float, Botry-Zen (again, on the grey market), incredibly received over $120 million of applications for $5 million of 10 cent shares. Post-float, the shares raced up to 50 cents and currently trade at about 20 cents. What most investors fail to realise is that they are backing Paterson's undoubted acumen on unequal terms. The average cost for his 35 million shares? About 0.001 of a cent!

Bad buyers, even worse sellers

Kiwi punters often select the wrong shares to start off with, but where they let themselves down even further is by not selling when the obviousness of their mistake becomes apparent. The usual recourse is, "I can't sell at these levels, I will make a loss".

Logically, an investor's entry cost is completely irrelevant when considering the question, "Is it wise to sell or to hold at current prices, given the company's prospects?"

Because of this reluctance to sell such shares as Air New Zealand and Brierley Investments, local investors have exposed themselves to further losses. It's funny how people will travel miles to the nearest Warehouse store to save $10 on a barbecue, but they will let their finances rot at great cost because of an emotional unwillingness to face the reality of a loss.

Buying the arse end of every trend

Many New Zealand investors are only keen to buy shares when they read about a strong sector in the newspapers. By then, it's normally too late. One broker friend told me of attending the phones between Christmas and New Year a couple of years ago and receiving large numbers of orders for strange shares he had never heard of, from clients on holiday reading the glossy finance magazines: "Buy me IT Capital", "Buy me Strathmore", they enthused.

The "new economy" phenomena had run a powerful course in overseas markets before we even heard of it in the New Zealand media. We had no e-commerce companies in the market initially, but when there is a potential demand a supply is created. New Zealand entrepreneurs and opportunists formed the most unlikely set of e-stocks and, sure enough, the punters bought it (figuratively and literally).

The sharemarket as a $2 shop

Many individual investors have a fascination with "penny dreadfuls", as if such "cheap" shares are somehow better than "expensive" shares over $2. Certainly, most investors shy away from anything over $10. This is illogical - in most cases a $10 share has the same chance of doubling as a 10-cent share. Indeed, most $10 shares in New Zealand have got to such a level due to superb performance (Sky City, Fisher & Paykel, Baycorp) and investors would be well advised to continue to back such well-managed companies.

Even when playing safe, we don't

Even New Zealand investors shying away from the sharemarket and buying bonds manage to stuff it up. We tend to ignore safe government stock and head for higher yielding corporate bonds (often called capital notes). Rates on junk and semi-junk subordinated debt in sophisticated markets like the US tend to trade 4%–6% above government stock rates. Typically the premium in New Zealand is only 2%–3%, as we misprice the risk. New Zealand investors often buy any bonds with a brand name behind them, no matter how onerous the small print and how highly geared the issuer. Those who brought Metropolis bonds without reading the small print and without a cynical eye are paying the price.

So what is the answer to protecting New Zealand investors from their own stupidity? Education? More regulations?

Most importantly, investors need to get their expectations down, stop taking big risks and concentrate on getting rich slowly, rather than getting poor quickly.

Disclosure of interest: At the time of writing Roger Armstrong owns shares in F&P

Roger Armstrong
finn.ltd@ihug.net.nz

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