The internet is packed full of these hotshot ‘investors’ who are ready to reveal all of the best shares to invest in to ‘trust me, you’ll be rich if you invest’. I don’t know about you but that doesn’t seem to give me much reassurance. Instead, it would be nice if people just talked about what NOT to invest in for a change.
In short, you will always want to avoid investments that are incredibly overvalued or investments that have a very low trading volume. An overvalued share is more likely to drop than it is to rise and a low trading volume means there may be difficulty selling your shares if no-one is looking to buy.
Now you’re going to have a few questions like, how do I tell an investment is overvalued? What is trading volume? How do I find the trading volume? Well – I have the answers you are looking for!
Identifying overvalued investments
To reiterate what an overvalued share is – it is a share that has a share price above the book value. So what is the book value of a share? Essentially, if you take the net assets of a business and divide it by the number of shares issued – that’s what the book value of the share would be.
The best way to find the net assets of a business is to go and look at their latest company accounts. You can either find them on Companies’ House or they are usually included on the company’s information page when you look them up on your investment platform.
It’s really important to note that there are some valid reasons why a share may LOOK overvalued. This could be because there are potential talks of an acquisition/merger or it is a very established business that has an element of brand reputation built into the share price (which they’re not allowed to account for in their accounts).
What is trading volume
Trading volume represents the amount of shares that are being traded. Well, now you might be thinking why is the trading volume so important? Why should I care how many people are buying/selling the shares?
What you’ve got to remember is, as much as it seems that you can invest into any company you want – there are a finite number of shares issued by every company. If you try to buy shares but there are no more left – you can’t invest!
The real issue comes when we’re looking at this from the otherside. Say you find an investment and you love the look of it – think it’s going to do great! You buy and hold, then you hear some bad news about the share and you want out. If there is no one on the market to buy the shares from you – you can’t sell them! You’re stuck with a share and can’t do anything but watch it fall!
How to find trading volume
If you’re investing using any sort of reputable investment platform, you should be able to find the trading volume (sometimes just referred to as ‘volume’) in the key figures of the share.
On Hargreaves Lansdown, you can see it here:
Of course, we want a lot of trading volume as this means there are lots of buyers and sellers so you won’t be stuck with anything you don’t want!
What should you look for in an investment
We’ve covered what sort of investments you should stay away from – overvalued shares and low volume shares. However, you’re going to be left scratching your head thinking ‘well, what SHOULD I invest in?’.
Ultimately, you should never invest in any companies that you haven’t researched. Research is so critical to any investment strategy as it allows you to completely remove the emotion from investing. Knowing you’re in a great share means you can ride out the peaks and troughs of short term volatility.
Additionally, you want to invest in shares that are the exact OPPOSITE of what we’ve described above.
How to go about researching an investment
Go through their latest set of accounts
The best way to research an investment is to take a look under the hood of their finances. With the bigger companies, if you go to Companies House and find their accounts – there is going to be an INSANE amount of information for you to read through. Once you’re happy with all of the directors reports and their stats & figures, you can move onto the next step.
Analyse historical trends
This is what most people do anyway – they like to make sure that the share price has been going up consistently before they buy in, but this is as far as their analysis goes.
When you analyse historical trends, try to see if there is any seasonality to their share price – are there particular times of the year that it dips? If there is, make sure you aim to buy in at these points to maximise your return.
Also utilise as much other information as there is available. For example – my Hargreaves & Lansdown screenshot shows a wealth of different information aside from the trading volume. You can compare current figures to previous figures to help establish trends.
One thing to note is that you wary of buying shares that are continually going up. This is huge sign that the share may be overvalued. The shrewd investor gets excited when the market goes down and get scared when the market goes up… this is a great quote from The Intelligent Investor. If you want to learn more on the Intelligent Investor, it’s on my Recommended Books list for wanna-be investors which you can go check out.
Summary
To summarise, you want to ensure you stay away from shares that are overvalued and have low trading volume. However, you need to consider that some shares may seem overvalued but research needs to be done to determine whether it’s an inflated share price or something different.
You should always be doing your research before you make any investments and consume as much information regarding the investments to ensure you’re making the most informed decision you can!