The return on an investment is determined by two factors – the prospects and the price you pay for those prospects. If you pay too much for the prospects, the total return on your investment can be as poor as an investment with poor prospects.
Imagine there was an investment with great prospects, but you had to pay a hefty price for that investment because everyone was already excited about the prospects of that investment. Now imagine you came across another investment with poorer prospects, but it was very cheap. How would you compare these two investments? That is the question every investor must answer.
When we look to the immediate future, it is easy to imagine poor prospects from our investments, especially for South African investments. It is easy to imagine that American companies, for example, have much better prospects than local ones.
However, the return on our South African investments will not be determined by just the prospects. It will be determined by the price we pay for those poorer prospects. Depending on which measurement of value you use, it looks like investors will pay nearly 50% more for American companies than for South African companies, even if they have similar prospects.
Is it then so clear cut that American companies will give better returns than South African companies? Perhaps not.
Thankfully, we do not have to choose one or the other, we can invest in both. Many investors don’t because they have such low expectations from South African investments and fail to remember both price and prospects.
Just remember. Poor prospects do not necessarily equal poor returns. It depends on the price.
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//3 July 2020