Question

It is often stated for share market investing that a good company makes a good investment. We may define a good company as one that has experienced rapid growth (in sales, earnings or dividends) in the recent past.

Required:

1. a) Discuss some of the reasons why shares of good companies may or may not turn out to be good investments.

2. b) As a basis for investing in shares, investors often look at (recent) past share prices and are more encouraged to invest when the current share price is lower than these (recent past) levels. Given your expertise in finance, comment on whether you consider this to be a suitable investment strategy.

Answer 1

Part (a)

There are several reasons why shares of good companies may or may not turn out to be good investments:

• Excessive valuation: The company is good but is already fully priced. In that case, scope of further appreciation is limited and hence may not turn out to be a good investment.
• Not a darling of institutional investors (IIs): IIs are market movers. If because of some reason, a good company remains out of notice of IIs, the price of the stock move in a limited band. Hence, it may not turn out to be a good investment.
• Caught in a tide of time: Short term issues, cash flow crunch or decline in business may prevent an otherwise good company from giving returns.
• Macroeconomic factors declining: The markets are falling; or pandemic situation (like the current Covid 19); irrational market behavior; uncertainty in economy - these factors can also prevent a good company from turning out to be a good investment.

Part (b)

Experts across the globe has successfully failed to design an investment strategy that can be suitable all the times and for everyone. Hence, I don't believe anyone can design a suitable investment strategy or comment on the suitability of the strategy of buying shares when its prices are lower than those levels in the recent past. What is being talked about here has a flavor of technical analysis. I believe investment should be done on the basis of fundamental analysis. Hence, I will not be a supporter of the investment philosophy talked about here.