Why a falling stock market isn’t always a bad thing!

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The one time when a falling stock market is NOT a good thing is when you want to take money out of the market in the near future – your portfolio can move horrendously against you within a matter of weeks if not days.

There is, however, a time when a falling stock market is a GOOD thing – that’s when you’re actually putting money into the market (as I have been doing over the last couple of years).

Now I’m not saying now is the right time for YOU to invest in the stock market – we all have our own reasons for investing (or not, as the case may be). My investment strategy, time horizons, attitude to investment risk etc will probably be different to almost everyone else’s so the actions I take may not be the actions which you should take!

The stock market performed a fantastic turnaround in 2009, with the FTSE100 rising from 4,434.20 at close of trading on 31st December 2008 to 5,412.9 at close of trading on 31st December 2009 – an increase in the FTSE100 of 22.1% during 2009.

Who knows where it will go next?!

Well, anyway, as part of my broader portfolio, I bought some shares in December in Tullow Oil (TLW.L) which is an oil drilling and exploration  company with interests in the African continent as well as other geographical areas. At the time I bought them, their shares stood at £12.99 per share. I had £1,000.00 to invest and therefore was able to purchase 76 shares back in December.

There has been a certain amount of volatility in the stock market recently and today I noticed that their share price had in fact dropped to £11.62 per share – a fall of £1.37 per share or 10.55% compared to what I paid for my shares back in December.

Now many people would be unhappy about this – not me! I saw it as a buying opportunity. I therefore decided to purchase another £1,000 worth this morning.

I am in this for the long run and will possibly hold these shares for in excess of 5-10 years so I took advantage of the recent fall in price to add more shares to my portfolio and benefit from pound cost averaging.

So what does all this mean? Well, I was able today to buy these shares at £1.37 per share less than I paid for them in December. I have drawn up a spreadsheet to demonstrate the benefit to me of this course of action.

 

 

I have included the dealing costs and stamp duty (0.5% on purchases) to take full account of the trading situation. You can see from row 1 that the total cost of my purchase of 76 shares in December was £1,007.28 giving a total acquisition cost per share of £13.25. Today I bought 86 shares at £11.63 and row 2 shows the total acquisition cost of £1,019.12 or £11.85 per share. So my purchase today cost me £1.40 per share less than in December.

Now here’s the interesting bit!!!

The second half of the spreadsheet answers the question “at what price per share do I have to sell to get my money back and break-even?”

Row 1 shows that had I not bought those shares today then to recoup the £1,007.28 outlaid in December, together with the £14.95 dealing charge to sell, I would need the Tullow Oil share price to hit £13.45 (last column) – this is the break-even price for my holding as it stood prior to today’s purchase.

Now consider the next row down – because I was able to reduce the average buying cost of my two lots of shares in Tullow down to £12.51 i have “pound cost averaged” down the cost of this holding in my portfolio.

The second row shows that to recover £2,026.40 (total cost of both the purchases in December and today) together with dealing charges of £19.95 (next tier of dealing charges) I would need to sell the shares for a minimum of £12.63 per share.

So in summary, had I only bought the December shares I would need Tullow Oil share price to hit £13.45 to break even.

Now with today’s “cheaper” shares I have reduced this break-even share price down to £12.63 per share – 82 pence per share lower. In effect, each and every penny that the Tullow Oil price rises over and above £12.63 is profit to me!

This therefore gives me scope for larger gains at a later date when I ultimately sell this holding.

If the price drops even further I will consider whether to invest further funds to reduce my break-even price even further.

Warning!

This is not a recommendation to buy shares in Tullow Oil or indeed that share ownership is suitable for YOU! The value of shares and the income from them can fall as well as rise and if the company went bust I could lose all my money. Do not act on this article without first taking suitable advice from a qualified stockbroker or financial adviser. You have been warned!!

What is a Company Share?

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What is a Company Share?

A share in a company is just that – you own part of the company. If it is a publicly quoted company, then yes, admittedly, your share in that company may not carry much control but you do own a share in the company with a right to attend and vote at the company’s Annual General Meeting, as well as the possibility to receive any dividend payable the company and the opportunity to make a “capital gain” is the share price increases.

When we talk about shares we are generally considering those shares in Public Limited Companies (PLC’s) which are quoted on the stock exchange or AIM (Alternative Investment Market – a market for shares in smaller companies).

How are Shares Valued?

A share is a tradable investment in a company and, as such, its price is not fixed but determined by the power of supply and demand within the marketplace.

If more people want to buy shares in Company A than sell shares in Company A, the price of the share will increase, until the number of people who are willing to sell their shares in the company matches the number of people wishing to buy shares in the company.

Conversely, if a lot of people wish to sell shares in a company, and there are too few buyers, the share price will fall – typically demand for any share will increase as the price falls as more and more people can afford to buy that share.

Why own a Share in A Company?

There are basically two ways in which a normal investor can benefit from owning a share in a company – capital growth and dividend income.

Capital growth occurs when the value of the share increases over time – many investors will review the stock market on the lookout for shares which they feel are currently undervalued, based on what they feel will be the future trading outlook for the company, and hence profitability, of the company in which they wish to invest.

For example, company X has a current share price of 90 pence – you have done your research and have concluded that company X has product Y at the research stage and when launched next year, product Y will increase the amount of money flowing into the company, with a corresponding increase in profits.

You feel that based on the information you have that the shares in Company X will be worth 130 pence in the next 12 months. You therefore buy the shares in company X today at 90 pence and hope that they will increase in value to 130 pence, at which point you plan to sell and make 40 pence profit (less any dealing costs and taxation which you might incur along the way).

Profiting through Dividends

The second way to benefit from investing in a company share is through receipt of a “dividend”. When a company makes a profit, the board of Directors will meet to discuss what proportion of the profits will be retained to help fund and grow the company, and what proportion of profits will be distributed to shareholders, in the form of a dividend, to provide the shareholder with a return on their investment.

Are there risks involved?

Yes – the price of the share is determined by the market (supply and demand) for the shares – if more people want to buy the shares than sell them the price will rise, and conversely, if more people wish to sell than buy the price will fall.

Firstly, if you buy a share in a company today for say 120 pence, there is no guarantee that that share price will be maintained at 120 pence – it could go down as well as up. All investors need to be aware of this before making an investment in a single company share – the investor needs to ask themselves “what effect on my wealth will it have if the share I am buying falls considerably in value?”.

Secondly, there is also the possibility that the company could “go bust” or cease trading. In this scenario, liquidators would be appointed to realise whatever they can from the assets of the company and to repay any debts the company owes, tax outstanding etc. Ordinarily shareholders in this respect fall way down the pecking order – it is not uncommon in the case of insolvency for the ordinary shareholders to receive just 1 penny in the pound on their investment, if anything.

Can I reduce the Risk?

Yes – if you have sufficient funds to invest you could buy a “portfolio” of shares in more than one company – by investing in a range of shares you are hedging your bets by not having “all your eggs in one basket” – some shares may rise in value, some may fall in value, some may go bust – your hope is that more of the shares will make you a profit than ones that make you a loss.

If the amount you have available to invest is rather modest then you could consider investing in a “mutual fund”. A fund manager runs the fund and takes money in from a large number of investors – the fund invests in a diversified portfolio of shares or assets in line with the investment objectives of the fund.

The investor in this scenario benefits from the active management of the fund by a professional management team as well as the ability to invest in a wide range of different companies thereby reducing the risk of their investment.

Learn more About Company Shares

“Investing in Shares for Dummies” is a great introduction to this fascinating topic. Buy now from Amazon.