Cost Averaging: Investment Strategy for Selected Philippine Stocks
*Benjamin D. de la Cruz
Introduction
Investment must be safe, secure, and whose return must exceed that of a savings account. Savings are invested with the end in view of making additional profit for the saver. It is therefore imperative for an investor to develop an investment strategy that will maximize the return on investment.
Background of the Study
When people have excess funds, they look for investment that will give them a return that will provide for their future needs. A share of stock of a company requires a long-term investment of funds rather than placement of savings in a bank deposit.
Some investors go to the stock market to invest their excess funds or savings without the benefit of a thorough understanding of the market mechanism and an apparent lack of a strategy to employ. Some even make investment, hoping to make a substantial return for a short period of time.
The researcher feels that to improve the current situation, there is a need to look deeper to find a strategy that will provide a better way of investing in the stock market.
In the United States, cost averaging is a popular investing strategy. This paper intends to provide an investment solution to local investors by doing a simulation using the cost averaging strategy. The simulation will test the cost averaging approach for two Philippine companies.
Statement of the Problem
In this paper, the researcher intends to find out if cost averaging will work as an investment strategy by doing a simulation on two Philippine companies. San Miguel Corporation, and Philippine Long Distance Telephone Company. Specifically, the study through simulation, answered the following:
1. What is the cost averaging investing strategy? If an investor puts in a fixed amount of investment regularly over a long period of time, would he come out ahead?
2. By how much would the investor be ahead if, by cost averaging, he bought these shares at the average of high and low prices of shares for the same period?
Research Paradigm
Using an input-process-output model, the conceptual paradigm was designed to illustrate graphical dimensions involved in the study.
Methodology
This section explains the research design and procedures which were followed in the conduct of the study.
Research Design
The research design used the descriptive evaluative method of research. This method of study describes a particular situation after which an evaluative judgment is done. The researcher felt that this was the appropriate and effective method of research for the study.
Descriptive method is a general procedure employed in studies that have for their chief purpose the description of phenomena. It is also a design, which describes the nature of a situation as it exists at the time of the study and explores the course of particular phenomenon.
Descriptive is a basic method of reflective thinking in seeking solution of a problem. The researcher thought that this scheme would ensure the attainment of the specific objectives of the study and a quality research output.
Procedure
An excel spreadsheet model named bencostavg was developed by Engineer Virgil Leslie Fonacier in collaboration with the researcher to do simulation on the stock cost, and price averages. Data on market stock high and low prices were inputted and processed to come out with price and cost averages. The data were taken from the annual reports of San Miguel Corporation (1978-2003) and Philippine Long Distance Company (1997-2001 Quarterly).
The model tried to answer the following questions:
1. If an investor puts in a fixed amount of investment, regularly over a long period of time, would he come out ahead?
2. By how much would the investor be ahead if, by cost averaging, he bought these shares at the average of high and low prices of shares for the same period?
Presentation, analysis and Interpretation of Data
From the researcher's findings, analysis, presentation, and interpretation of data, the data and results of the simulation were textual and tabular. The results were based on the problems and objectives that were set at the outset of the study.
What is the cost averaging investing strategy?
Based on the review of literature and studies, the researcher found that strategy is a plan or course of action that is of vital, pervasive, and continuing importance. While, investing is the committing of current fund in anticipation of the receipt of an increased return of funds at some point, investing strategy, is^he plan or course of action that is of vital, pervasive continuing importance of committing current funds in anticipation of an increased return of funds at some point.
Investment therefore should be viewed as a long-term commitment of funds. In business, long-term suggests a period of more than one year or one operating cycle. The investor therefore must be prepared to anticipate the fact that the fund invested will not be available for current use. Investment fund must be considered in excess of current requirement. It may also be viewed as reserve fund for long-term use.
The investment must be available at the anticipated value in the future. Investing must be prudent and conservative. There is therefore a need to find an investment strategy that optimizes the placement of funds.
Investing in stocks is a long-term placement of excess funds. To be prudent and conservative, this study did a simulation of cost averaging as an investment strategy.
Cost averaging is a method of buying the same amount of a stock each period so that the price investor buys averages out over time. This systematic approach saves the investor from the turmoil of moving in and out of a number of stocks, or trying to time stock purchases. The investor can disregard current market conditions and emphasize long-term growth.
Investor may buy low or high, but in the long run his total cost is averaged. Fewer shares are purchased for the same amount of money when the market demands a high price per share; more shares are purchased for the same amount when the share price drops. Most importantly, dividends always are reinvested and automatically become parts of his cost averaged portfolio.
Aside from the obvious discipline that cost averaging encourages, studies show that over time, an investor can purchase more shares at a lower than market cost through cost averaging, than if he tries to buy the shares by timing the market.
There is a better chance for reward for an investor in a volatile market. As long as the investor is in this for the long-term of 10 years or more, he can assume that the value will go up since the market has higher averaged returns annually. This return should be higher than what most banks can give.
While cost averaging cannot prevent loss in a steadily declining market, it can prove to be a very successful investment strategy, making the most of market fluctuations over the long term. Investors can further reduce the risk through investment diversification. Choosing a portfolio with a mix of common stock, bonds and preferred stocks offers a greater protection against market risk than a common stock portfolio.
If an investor puts in a fixed amount of investment, regularly over a long period of time, would he come out ahead?
The simulation result shows that over the period 1978-2001 both SMC A and B shares of stocks the investor was ahead if he puts in a fixed amount of investment. If the investor puts a fixed amount of investment of PI 8,000 and P23,150 annually on SMC A and B respectively, these initial investments in 1978 followed by annual investment of the same amount accumulated to P432,000 and P555,600 respectively. This translates to an average share cost ofP37.00 versus average share price of P58.32 for SMC A. In the case of SMC B the average share cost was P41.94 as against average share price ofP76.16. In both cases it was to the advantage of the investor.
In the case of PLDT Common and ADS shares, the simulation result shows that over the period 1997-2001 both PLDT Common and ADS shares of stocks the investor was ahead if he puts in a fixed amount of investment. The initial investment of PI 1,525 and $300 respectively in the first quarter ofl977 followed by annual investment of the same amount accumulated to P230,500 and $6,000 respectively. This translates to an average share cost of P805.94 versus average share price ofP847.63 for PLDT Common. In the case of PLDT ADS the average share cost was $19.42 as against average share price of $21.67. In both cases it was to the advantage of the investor.
By how much would the investor be ahead if, by cost averaging, he bought these shares at the average of high and low prices of shares for the same period?
The SMC investor would be ahead, if by cost averaging the shares were bought at the average of high and low prices annually. The investor was ahead at the end of 2001. Using the high closing prices amounted to P50,909,898 and P81,132,798 or a difference ofP50,477,898.and P80,577,198 respectively. This is shown on Tables below.
In the case of PLDT Common and ADS shares, the simulation result shows that on most quarters of the years the investor was ahead. However in the last quarter of 2001, using the high closing prices the total value of shares acquired amounted to PI 88,895 and $3,835 for Common and ADS respectively. This is lower than the accumulated acquisition price ofP230,500 and $6,000
The result shows that over a long period cost averaging works for the investor, particularly with large corporations with proven track record like SMC and PLDT. The investor should however, be very conscious of the development internally by attending regularly the stockholders meeting and press releases.
The cost averaging formula appears to work with stocks that fluctuate substantially. Quality stocks that will continue to produce above average growth in revenue and earnings, like SMC and PLDT become attractive.
Summary, Conclusion and Recommendation
Summary
Results of the analysis indicated these findings:
1. The simulation proved that cost averaging works with SMC and PLDT shares traded in the Philippine Stock Exchange.
2. The gains were substantial over a long period of time when the investor holds on to the investment.
3. There were fluctuations in the increases due to stock dividends, cash dividends and stock splits in the case of SMC.
4. Both SMC and PLDT had significant change in ownership and management over the years. This contributed to the fluctuations in market values of their stocks
5. The investors gained substantially, if the cost averaging strategy was employed in investing.
Conclusions
In the light of the findings derived from this simulation study, the following conclusions are deduced:
1. Cost averaging as an investing strategy works on the basis of the result of the simulation. The selected stocks are from profitable companies backed by large asset holdings. Care should be taken in selecting companies to invest. Using SMC and PLDT as benchmarks would increase the chance of success.
2. An investor generally, is ahead in terms of the cumulative cost on investment placed versus the high market value of the shares. The investor should determine the amount he could afford to invest for the long term, as well as the board lot requirement of the stock exchange.
3. The gains are substantial over a long period of holding the investment. When the gains are known, the temptation to withdraw must be tempered, since cost averaging requires the maintenance of the investment over a long period of time.
Recommendations
After a careful review of the findings and analysis of the results of simulation, these recommendations are presented:
1. Prospective investors should gain substantial knowledge of cost averaging if they do simulation of the stocks of intended investment. They can only do this by using the annual reports and other company publications where share prices and movements are available.
2. Prospective investors should set aside an amount intended for regular periodic investment, whether, monthly, or annually or some other time.
3. Cost averaging works best with stocks that fluctuate substantially. Prospective investor should, however, avoid high risks stocks. He can only buy those shares of companies with proven track record in their operations. Cost averaging will not work if prices continue to move downwards in price.
*Benjamin D. de la Cruz is Lecturer and MBA, Area Head at Jose Rizal University Graduate School
