Monday, March 12, 2012

The Theory of Relativity

When Coffee Bean first arrived in Johor Bahru many years ago, I was shocked by the prices. Almost Rm 10 for a cup of coffee, when mamak shops were selling for Rm1.20. However, that sort of disbelief has now faded away. Heck, nowadays I patronize Coffee Bean and Starbucks regularly, not to mention the Pappariches a Station Ones. The prices are still in a way exorbitant, but the unwillingness to spend on them has slowly died away.

A 10 ringgit cup of coffee has become alright because many other coffee houses have sprung up and begun to sell coffee for Rm 5, Rm 7 and Rm 9. The average cup of coffee is not Rm1.20 anymore.

5 years ago, a double storey terrace house in Johor Bahru was considered to be on the costly side if it exceeded Rm 300,000. But now, a 500,000 ringgit one does not seem expensive anymore because a simple apartment has risen to 350,000 ringgit. Even though the actual usefulness of a house has not changed, our perception of its value has changed due to external influences.

Dollars and Cents are simply numbers which humans assign value to. How much is a dollar worth is actually a very difficult question to answer. The value of things is always relative to other things. We decide whether a cup of Starbucks coffee is expensive based on how much other coffee houses are charging.

Interestingly, this intuitive method of assigning value does not translate nicely over to the stock market.

The most basic mistake is when people compare ‘coffee with wine’. If a cup of coffee is Rm 5 while a glass of wine is Rm 50, does that mean the coffee is underpriced while the wine is overpriced? When it comes to stocks, many people seem to think so. They will never pick the Rm 50 glass of wine over the Rm 5 cup of coffee because it is more ‘expensive’, never mind that it could be a glass of Domaine Romanée-Conti they are looking at.

The second common mistake is when investors have no idea what are the ingredients in the cup of coffee they are buying. You can’t apply relative valuation if you do not know what you are valuing. What’s in a cup of Maybank shares? What’s in a cup of Amway shares? What are the ingredients of this brew you are buying?

A share is considered high-yielding at 8% if FD returns 3% and EPF gives 5%. But if FD rose to 10%, will the 8% share still be considered good? It is all relative.

Once the investor is well-acquainted with the contents represented by the piece of paper known as a share certificate, the value of each share will suddenly be made clear in his eyes. When you know what different shares ‘contain’ and begin to compare them, you will easily be able to gauge the value of each relative to other available choices.

Investors should not invest before they know what they are investing in. Knowing what you are buying is the first order of business.

Andrew Chua

1 comment: