Beware The Dreaded Stock Tip!

As you can imagine, as a personal finance writer, I get more than my fair share of requests for stock tips.

My answer is usually the same each time:

"Just get yourself a passive index tracking ETF, puts some cash in it and forget about it".

That also usually doesn't do the trick as people want specifics so the level 2 answer is

"If I was starting again with my investment portfolio I would pick Vanguards' VTI, VOO or MGK, or even better, all three"

That is usually enough to get them on Google doing some "Research". I always, always, always caveat the answer by adding

"That's what I would do, but I'm OK with losing everything, if you're not, stick it in the bank".

I feel that pretty much absolves me of anyone turning up at my door with a duffel bag full of the only worldly possessions they have left expecting me take them in because I was wrong!

Occasionally I get given unsolicited stock tips, usually for individual stocks and usually for obscure ones I've never even heard of. They usually have a story attached about some amazing turnaround or that it was whispered by some prolific guru investor that just felt he had to share his latest find with someone with little or no investment experience.

I've even invested in a few, more so when I had no clue what I was doing but I was armed and dangerous with a stockbroking account. I would buy some of the hot tip stock as soon as possible, you know, before all the gullible plebs find out (little did I know, I was said gullible pleb) and would then be surprised when the stock price didn't go up 10,000,000% in the next week. I would of course have told at least 10 friends about this amazing opportunity that I was in on the ground floor with and a couple of them at least would have copied my behaviour, and that is how stock tips spread.

The only thing I can categorically say about every single stock tip I have ever had is:

Not one of them made any significant return, in fact, significantly more of them generated a loss than a win.

Why? Because stock tips are generally a massive pile of horse manure! mostly for the following reasons:

• If you had the numbers for next week's lottery, would you share them with somebody else?

• An actual really juicy stock tip would require some kind of inside knowledge from somebody in the know. That is called insider trading and is illegal and would put that somebody in jail

• If it didn't involve any insider trading, it's based on public knowledge anyway so you can go check it out easily on the interweb before you invest. Which means everybody else in the world can, do you think the literally thousands of stock analysts missed something that your mate Dave spotted?

• The stock tip rumour was most likely started by somebody who bought the stock and wants to inflate the price by encouraging lots of other people to buy it too so they can sell their stock at a profit. This is called a pump & dump scheme and is also illegal although seems to be increasingly common.

• Even if your mate Dave was lucky enough to be in possession of some legal insight that a company stock was about to shoot through the roof, how long do you think it took to get from the board room announcement to Dave? It would need to be minutes to beat the entire stock market.

I think you get my point.

My most famous stock tip I ever invested in was Dragon Oil which had the ticker DGO on the London Stock Exchange. I think it would have been around 1997 ish, I was a camera technician back then on a pretty lousy wage. I would have probably been earning around R2,000 / $130 / £100 per week back then and I was 20 years old. It was the company receptionist Jenny that gave me the tip. She and her partner had bought some stock and the story was something along the lines of that Dragon Oil had discovered a massive oil field in the middle of nowhere and once they were able to get the oil out they would be making billions and the share price would go skyward. The share price was 3p so I immediately bought R5,000 / $333 / £250 worth of the stock which considering my age and my salary was probably my life savings at the time.

I held that share for years (well probably 3 years) and it did.....absolutely nothing. oh yes, the price went up, a lot, but only because it had to keep doing rights issues and stock consolidations to remain afloat. I think I got back about half what I'd invested after the three years. Jenny and I never spoke of it again, in fact, somewhat ironically, I left that job in 1999 to join a massive gas and oil company.

From what I can tell, Dragon Oil was bought out by a private oil exploration company in 2015 and the share price was 800p. You may now be thinking I was an idiot as if I'd held on for 17 years I would have seen a return of 26,500% and my £250 would now be worth £6,625,500 but you'd be wrong (thankfully).

It's hard to see what really happened but the best info I can find shows that from 1998 to 2015 whent the company stopped trading, the overall return would have been 137.3%. That would be an annual rate of return of just 8% which is more like 3% if you allow for compounding.

In a twisted way, that gives me more comfort. And that has been the theme of pretty much every stock tip I've ever been given.

So why do so many of us blindly invest in stock tips even though it's blatantly obvious that they're either a waste of time and even if they're not, they could be illegal? Simple

• Greed

• FOMO - Fear Of Missing Out

• Excitement - The feeling of power of being "In the know" before others

• Greed

And I guess I would say that I've never learned my lesson. I still occasionally throw a few sheckles at a hot tip. It's just that these days it's probably the same amount as I invested in Dragon Oil but instead of that amount representing 100% of my life savings, it's more like 0.0003% of my hard earned cash.

I treat stock tips as the equivalent of throwing a chip on red at the roulette table these days, it's good for a bit of excitement but there's a good chance I'll lose it and at best, I might get to double my money.

It worries me though at the moment that stock tips seem to be making a resurgence and in these days of social media, they spread like wildfire.

The latest "Tip" that I see flying about everywhere is for a little known company called Aveng. For the last few months I've seen Aveng pop up everywhere from blogs, to podcasts, across twitter I even got it tipped by a friend recently.

Of course I bought some!!!

I didn't buy some Aveng shares because I think it will do spectacularly well, I bought them in the name of science. Judging by how much airplay the stock is getting, I'm guessing thousands of South Africans will have bought Aveng shares, some unfortunately will have bought them with money they simply don't have. That's what really prompted me to write this post.

I'm not saying that I think Aveng is a bad stock, in fact the story supporting the tip is that Aveng has turned around from having years of massive losses to posting a profit, which by what I can see doing some internet research, seems to be true. It's no secret that finding a company that has managed to turnaround it's fortunes is a good way to make a return.

If you're quick enough to invest before that turnaround is already priced into the stock.

And that is what most amateur investors fail to understand. Most stock prices have a lot of future built into them based on news from the past.

This is what I find out about Aveng that might highlight that risk:

• In February 2021, the SA national media started to report that Aveng had recorded it's first headline profit since 2014.

• On that day, the share price was 2c and had been 1.4c a couple of weeks earlier so had already increased by 42%

• By mid March, the share price had risen to 3.7c a total return of 164% since before the announcement

• By 10th August, the share price had grown to 6c, a total growth of 328% since February.

• At the end of August, Aveng published it's full year results confirming that it had indeed delivered headline earnings of R751m / $50m / £37.5 m versus a loss of R950m / $63m / $47.5m in the previous year. Definitely impressive

• The share price continues to fluctuate between 5c & 6c.

So looking at that timeline, if you had invested in early February, you would have made a return of around 300%, which is amazing, but there is no way you could have known to do that as it was before the announcement was published that they had returned to profit in the public domain. So it would have been pure luck or something more sinister f you had invested then.

However, if you'd invested on the day the news broke, you should be around 200% up or simply you would have trebled your investment.

But you wouldn't, and here's why:

Due to Aveng being a penny share you would have lost 1c on the buy and sell spread imposed by your stockbroker meaning when the price was 2c, you would have most probably paid 3c (if you're the average man on the street) and if you sold at the high point of 6c you would have got 5c on the sell price.

Now, even if you'd been absolutely perfect with your timing, you would have made 2c a share on a 3c investment which is a 66% return.

So now the news is out, it's commonly known and a large part of the turnaround is now priced into the stock. Do you think it's going to go up another few hundred percentage points from here in a short period?

Me neither.

And this is why stock tips don't work (in my humble opinion). If you go search Twitter right now, you'll find literally thousands of posts pumping Aveng. Thousands.

What price did I get into Aveng? 5c, which means I paid 6c which is the price today. Do I regret it? Hell no, if the company continues to turn around it's fortunes the share price will continue to rise. But it won't happen in the next few weeks, it'll take years for me to see a big return on that stock and who's to say it's not a flash in the pan. It's a massively high risk stock because so many people bought in on the back of a "Red Hot Tip". It may be possible that it's already overpriced, I have know idea because I'm not financial analyst.

And that is the moral of the story, Aveng is possibly not a bad investment and it is truly a turnaround stock but unless you bought in late February / early March (6 months ago), the train has left the stable and it's simply a decent speculative investment.

Guess what? If I'd invested that money in a simple index tracker (like my favourite; the S&P500) in late February, I would have already made a 17% return based on no news, no hot tips and a massive amount less risk. Ok , maybe it's no so impressive but I would take the Pepsi Challenge that in the same 17 years that I tracked Dragon Oil, that the S&P500 will deliver a better return than Aveng.

That may be a bold statement so I'll see you back here in 2038 to see if I was right!!!

I don't give financial advice, I'm not qualified and it's not legal for me to do so but I do think it's Ok to say be very careful when acting on a stock tip and definitely don't invest in a stock without doing your own research. If you have been tipped to buy Aveng or any other share, the first place to start is to read the companies latest financial results. They generally come with a presentation which is easier to read. A lot of the content still doesn't make sense to me but I taught myself to read a profit & loss report and understand a company's' balance sheet and compare it previous years. There's not many places to hide in a financial statement so I would recommend anyone who is serious about investing in any single stock to take the time to read and understand those few pages as a minimum. Most definitely do not get your invsting insight from Twitter!

Warren Buffett, one of the most successful investors in history famously said:

"Never Invest In A Business You Cannot Understand"

Until next time, keep living.