Factors influencing selection of stocks (Stock Investing)
This article was formally titled "3 Secrets to Stock Investing"
Introduction
Factors influencing selection of stocks (Stock Investing can be grouped into three. As the pace of
development in Africa continue to pick up speed, access to more capital has
become paramount. This has partly led to the emergence of several stock
exchanges on the continent. Prior to 1989, there were only six (6) stock
exchanges in Africa. However, as at 2010 there were 19 African stock exchanges (Agyemang, 2010). To all intents and purposes, stock exchanges are
created as a way of providing a platform for listed businesses to raise capital
from investors, in return for part ownership in the listed entity. Investors
make money from their invested capital either through dividends or capital
gains. The securities traded may be in
the form of shares, bonds and the like.
Stock investing or selection of stocks is a function of both subjective and objective variables (Virlics, 2013). Making decisions as to which stock to select does
not come easy to investors (Kengatharan &
Kengatharan, 2014),
possibly due to risk reward considerations.
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Stock investing driven by investor
decisions is very important in that it shapes how the market trends, which in
turn influences the health of a country's economy (Kengatharan & Kengatharan, 2014). After all, the
stocks represent businesses and the business employs the citizens of the
country and so if a stock is doing well because investors have chosen to
purchase it, it would impact on the economy positively. According to Kengatharan &
Kengatharan (2014),
“the stock market constitutes a gauge of the health of a nation’s economy. In
this sense, a gauge of Ghana’s economic health is its stock exchange, the Ghana
Stock Exchange (GSE).
There are a
myriad of factors that influence selection of stocks by investors. It has to be
said that the factors which determine stock investing amongst investors are
likely to vary from country to country and from stock exchanges to stock
exchanges. This may be possibly because of the heterogeneity of investors (Gunathilaka, 2014) as well as the environment. A working knowledge of these stock investing factors is the secret to stock investing. For example, whilst
dividend payout is significantly important to investors on the Nairobi Stock
Exchange in decision making, it is not, as far as investors on the Colombo
Stock Exchange, Sri Lanka, are concerned (Gunathilaka,
2014; Agongo & Mutswenje, 2014). For the purpose of this discourse,
stock investing factors shall be broadly grouped into three: behavioral,
demographic, macroeconomic/political factors (Barberis and Thaler, 2003; Kengatharan &
Kengatharan, 2014;
Ritter, 2003).
Behavioral factors
Traditionally,
it is thought that investors are rational and so would naturally make rational
decisions conforming stock investing decisions to “basic financial rules based
on their investment strategies and risk-return consideration” (Dunusinghe &
Ranasinghe, 2015: 1) as per the views of traditional finance theories
such as Capital Asset Pricing Model (CAPM), Efficient Market Hypothesis (EMH), and
Modern Portfolio theories. However, a number of studies indicate that the
behaviour of market participants and their psychology at any point in time may
influence their decision to either select a stock or not (Hodge, 2003). For
example, optimistic behaviours in investors tend to cause over reactions in the
market, making prices of stocks rise beyond what can be justified by a firm’s
fundamental. The reverse holds true for pessimistic behaviours.
Kengatharan &
Kengatharan (2014)
propose that there are four subcategories under behavioral factors: Herding,
Heuristics, Prospect and Market factors. Prospect occurs when an investor makes
a subjective decision on the basis of his own value system; herding effect in
finance is seen as the propensity of investors’ to buy or sell a stock on the
basis of what others are doing. In
a complex and uncertain environment like the stock market, certain guidelines
can be put together to form the basis for easier decision making on stock
investing or stock trading or to serve as a tool for predicting market trend (Kahneman &
Tversky, 1974; Ritter, 2003). These guidelines or “rules of thumb” constitute
heuristics. The table below provides insight into variables that make up each sub-factor:
Table 1: Behavioral factors influencing Stock Investing (Stock Trading)
Behavioral Sub-factors
|
Behavioral variables
|
Heuristics
|
Representativeness,
overconfidence, anchoring, gambler's fallacy, availability bias
|
Prospect
|
Loss aversion, regret
aversion, mental accounting
|
Market
|
Price changes, market
information, past trends of stocks, fundamentals of underlying stocks,
customer preference, over-reaction to price changes
|
Herding Effect
|
Buying and selling
decisions of other investors, choice of stock to trade of other investors,
volume of stock to trade of other investors, speed of herding
|
Source: Waweru et al. (2008)
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Every investment
comes with some level of risk (Francis, 1991). Investors react differently to
risks; a level of risk tolerable to one investor may be intolerable to another
(Cheney and Moses, 1999). This risk level may make investors behave irrational
at times. Investor risk aversion may either come in the form of loss aversion
or regret aversion as shown in Table 1.
Kengatharan and
Kengatharan (2014) in their study found that herding, heuristics, prospect and
market sub factors respectively accounted for 15.2 %, 13.3 %, 7.8 % and 6.0 %
of stock investing decisions by investors. From their results, it appears that
behavioural influence on investors towards stock investing is most accounted
for by the herding dimension, followed by heuristics. Not all the behavioral
variables in Table 1 were found to be significant. For instance, of all the
behavioral variables for heuristics only overconfidence and anchoring was found
to be significant. Overconfidence was found to have a negative significant
impact on investment performance, whereas anchoring registered a positive
significant impact on investment performance.
In another study,
it was observed that how investors perceived the worth of the firm was found to
be the most important factor in influencing selection of stock in Colombo Stock
Exchange (CSE), Sri Lanka (Gunathilaka, 2014). Other selection factors found to be of import on
the same exchange were risk, historical prices and accounting information.
Jagongo &
Mutswenje (2014)
working on factors that influence stock investing or stock trading by investors on the Nairobi
stock exchange observed some of the most important factors to be: reputation of
the firm, firm’s status in industry, expected corporate earnings, past
performance of firm's stock, price per share, sentiment on the economy and
expected dividends.
Macroeconomic/
Political Factors
Macroeconomic
factors such as high interest, inflation and exchange rates play vital roles in
how listed companies on the stock market perform and consequently on investor
decisions to select stocks. This is because: (1) high interest rates mean high
cost of borrowing for businesses, which may make them borrow less than they
actually need or use a chunk of their profits to pay the interests on the loans
collected; (2) high inflation rates imply a reduction in the purchasing power
of available funds or borrowed funds by listed businesses; whereas (3) high
exchange rates mean listed companies will spend more money to import the same
or less amount of inputs for their operations.
Working together,
these macroeconomic considerations may result in a firm performing well below
investor expectations, thus leading to a firm’s unattractiveness and that of
the entire stock exchange as a whole. A case in point was when in 1995 when the
GSE recorded a dreadful growth rate of only 6.3 % (Baah, 2011). According to Baah (2011), the poor performance by
the bourse was attributable to high interest, exchange and inflation rates.
Furthermore, findings from a study by Aizenman
and Marion (1995) found that macroeconomic variables (terms of trade,
inflation, real exchange rate) negatively correlated with investment by
investors. This means that as macroeconomic variables such as inflation and
real exchange rate increases, investment or stock trading diminishes.
Political factors such as General Elections, tax
increments, adherence to democratic principles and foreign political news may
influence an investor’s decision to purchase or not to purchase a stock. For
example, in Iran, political factors are given the most consideration before
stocks are selected (Yahyazadehfar, Zali, & Shababi, 2011). They report that on the Tehran Stock Exchange, political factors
accounted for 79 % of stock trading decisions by investors; whilst, economic
factors accounted for 47 % of the variation in investor decision.
Demographic
Factors
Demographic factors such as age, gender, marital
status and income and educational levels may significantly influence investor
stock investing (Hossain & Nasrin, 2012). Age and gender are probably amongst the most common demographic
factors that may directly or indirectly influence stock selection. According to
Bashir
et al. (2013), age and gender affect investment behaviours which in
turn affect stock trading decisions (Bashir et al., 2013). Younger people are more likely to take greater
risks than older people and also men tend to take more risks in stock investing or stock trading than females. According to Barber and Odean (2001), males
invest more than females; also, males invest more aggressively than females.
Investigating whether stock selection factors significantly differed between
males and females, Hossain & Nasrin (2012) found that it does.
Conclusion
In conclusion,
different factors come into play to influence selection of stocks and these
factors may be behavioral, macroeconomic and or even demographic. Which factor
or factors affect your investing (stock trading) decisions?
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References
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