When investing in shares it's important to have a long investment time frame, ideally at least five to seven years, because undoubtedly there can be volatility over the short term. Meaning shares can both increase and decrease in value quite erratically depending on a number of factors.
When a share decreases and the business fundamentals haven’t changed, it could be a good buying opportunity. Vice versa, it can often be wise to ‘lock-in profit’ by reducing your holding in a share that increases in value.
A recent example of share price volatility is Tesla, the company trying to produce affordable electric vehicles. Since the beginning of last year, Tesla has had a sharp decline in share price followed by enormous growth. Some of the drivers behind this volatility are as follows.
From January to May, Tesla almost halved in value. When the Model 3 (Tesla’s more affordable electric vehicle) was unveiled in early 2016, there were around 500,000 pre-orders for the car. Tesla struggled for the first half of 2019 to meet production and delivery requirements and as a result, was bleeding money. This was a major driver behind the share price reducing.
Tesla appeared to break through their slump well and ended up generating a large surplus of cash in the second half of the year. While they once again posted an annual loss, they actually reported a profit of $386 million in the last quarter of 2019 - pushing the share price up.
Now that Tesla has improved on their financials, the fans are back in full force and are backing Musk (Tesla’s founder and CEO) in for the long-term. Honestly, I hope they are right because the world would be a better place with his inventions and technology in every household and city. However, does the future profitmaking potential warrant such a dramatic spike in share price?
There are another group of people that can be held responsible for driving share prices – the short-sellers.
When things weren’t looking too good for Tesla, some people were ‘betting against it’ by shorting them. This means that if Tesla shares drop in value these people would make money.
When Tesla turned things around and the share price was improving, the short sellers were losing big time. Many of them cut their losses and stopped betting against Tesla. As a result, this further boosted the share price of Tesla as the overall market sentiment for Tesla increased.
In the short-term, it is important to understand that the value of a company is not only determined by their ability to make money and turn a profit. Some companies out there could be viewed as significantly ‘overvalued’ because people have faith in their long-term profit potential. Ultimately the share price will reflect the long-term earnings of a company, so it is still important to invest in companies with strong fundamentals.
Making sure that you only invest in shares and other growth assets (such as property) when you have a long investment time frame means share price movements are irrelevant in the short term.
Hewison Private Wealth is a Melbourne based independent financial planning firm. Our financial advisers are highly qualified wealth managers and specialise in self managed super funds (SMSF), financial planning, retirement planning advice and investment portfolio management. If you would like to speak to a financial adviser on how you can secure your financial future please contact us 03 8548 4800, email email@example.com or visit www.hewison.com.au
Please note: The advice provided above is general information only and individuals should seek specialised advice from a qualified financial advisor. The views in this blog are those of the individual and may not represent the general opinion of the firm. Please contact Hewison Private Wealth for more information.