When the capital market bubble burst in Nigeria many Nigerians lost billions of Naira in the capital market. To make the matter worst for some of these investors, they borrowed money from banks to invest in shares with the hope of making quick gain from price appreciation. This has made some of the so call investors to be in massive debt which they may never be able to repay. Some of the investors (both corporate and private individuals) lost their shares and other assets which they used to secure the credit facility that was obtained to fund their adventure in the capital market. The most surprising aspect of this unfortunate scenario is that most of the Stock broking firms which are suppose to be expert in capital market investment also fell victim of the situation. Can it then be concluded that capital market is a devil that should be dealt with only with a very long pole? No! It is nothing like that at all. Warren Buffet is the second richest man in the world. He made his fortune playing in the capital market. What then went wrong that made so many people to lose so much money when the capital market crashed?
What went wrong?
During the capital market bubble, majority of the players in the capital market including many of the so call “investment gurus” made their buy decision mainly on a factor which they do not have any CONTROL over. They made their buy decision only on the wrong assumption that the share prices will continue to rise. They did not realize that, the most important factor which determines the success or failure of any investment be it capital market or any other form of investment is the degree of CONTROL the investor can exercise on the cash flow from the investment. The more control you have the better your chances of surviving any capital market downturn.
The degree of control you can exercise on the cash flow from any investment depends solely on the basis of your investment decision. For this purpose, let me classify bases of investment decisions into two, namely Cash Flow basis and Price Appreciation basis. When an investment decision is based on Cash Flow, you have higher degree of control. On the other hand if the investment is based on Price Appreciation you have no control on the final outcome. To enhance your understanding of the Cash Flow and Price Appreciation concepts, I will briefly explain them.
Cash Flow Strategy
Here, the buy decision is taken only if the investment will generate positive cash flow irrespective of the direction of the share price movement. That is, computation of the return on investment is based mainly on positive cash flow that will be generated by the investment. The share of a given company is bought if only the return on investment at the ruling market price of the share makes economic sense without considering the future price appreciation. This is the investment philosophy that is employed by Warren Buffet and other people who win consistently in the stock market. When you make your investment decision using this strategy, you won’t lose sleep when the prices of shares begin to fall. It is the winning investment strategy.
Price Appreciation Strategy
The buy decision here is based majorly on price appreciation. Other sources of cash flow are either not considered or are given little or no attention at all. This means the investment decision is based primarily on a factor (Price Appreciation) which is outside the control of the investor. No analysis is done to determine if it makes economic sense to buy the share at the prevailing market price. No comparison is done with alternative investments to determine if there are better investment options that will give higher returns. This strategy is nothing but worse than gambling. Gambling, we all know is a game of chance. We all know that investment decisions can have a far reaching effect on our life; hence it should not be left to chance. This is a losing strategy; people who adopt this strategy begin to have high blood pressure when the share prices start heading south.
Are you scared?
Most people are now afraid of venturing into the capital market again because of their past mistakes. These investors are so scared that they will never play with the devil in the capital market even with the longest pole. However, for those who are willing to fail forward in their capital market adventure, this is actually the best time to enter the capital market. But let me sound a note of warning, before you invest a kobo of your hard earned savings in the capital market, always ask yourself this question: Without considering any anticipated future price appreciation, is this investment offering me the best possible returns on my funds? If the answer is no, I think you should rather put your money in fixed deposit and position yourself to take advantage of better opportunities that will surely come in future.
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