The best time to invest in a company's shares

By Tom Bulford Dec 08, 2009

Tom Bulford

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When I'm considering a growth company to buy shares in, I always think about the company's product demand curve.

Think about this curve being an italic 'S'-shape… but on a slant and stretched out. Like this…

The demand curve for any new product has three discrete stages. Only one of these stages represents a good time to invest. Let's start at the beginning, down there to the bottom left.

Our line is running along close to the ground, barely rising. This is the development stage of a new product. Whatever the product is – from the first motor car, to the Post-It note – there is a period when it is being developed.

Plans are made. Earnest marketing types sit round and talk about 'product positioning'. Boffins in the research area tweak the design. Production guys stroke their chins and work out ways of cutting the costs of manufacture.

This all takes time and money. This is money that is spent without anybody recording a profit; money that, in fact, may be wasted altogether if the product does not fly.

Eventually the moment of truth arrives. The product is launched. What will customers make of it?

There were many who doubted that the motor car would ever replace horse-drawn travel. The first mobile phone – which was the size of a brick – was viewed with scorn...
This is a crucial period. There are many questions that need to be answered with a yes if the product is going to fly: Will customers want to the product? Will they be prepared to pay the price? Can it be manufactured in sufficient quantity? Is there a profit in it?

Sometimes this is easy to predict. Take the case of a new cancer treatment. The need is so obvious that if the product works it will sell. The market will need little convincing.

At other times a latent demand materialises. Think of the cross-channel ferry. Before this arrived the idea of a weekend in Calais appealed to few. But make it possible to cross the water cheaply and easily and suddenly everybody wants to nip across to la belle France if only, to load up the car with Chateau Plonkeau.

Anyway, at this point of product launch the line on our 'S' curve starts to rise. It may rise suddenly and with great momentum or perhaps it may do so slowly and reluctantly.

The importance of the upward curve

Those companies that have developed the product – and there may be only one of them – start to make sales. Revenues flow and all those development costs are covered. The chief executive, with a glint in his eye, pushes up the product's price. Profits are made in ever rising amounts.

This is a golden time. Sadly it cannot last. Nothing is more certain in the business world than that a profitable business will attract emulators like moths to a flame. New entrants muscle in, launching copycat products.

For a while nobody minds. The marketing efforts of these newcomers expand the market even further, the sales curve accelerates upwards. But eventually things will start to go wrong.

A newcomer with an inferior product will cut his price in a desperate attempt to take market share. Demand from customers will be satisfied – once we have all bought a PC, for example, how many more can be sold?

Here we come to the section of the 'S' curve when the line starts to flatten out. Eventually it could droop. What does this represent? I saw plenty of evidence of what it represents when I took a walk through Oxford last week.

I passed Wine Rack, its windows announcing 'Closing Down Sale, 30% Off Everything'. I passed Borders bookshop, which advertised 'Last Few Days - Liquidation of All Stock.' And I passed Lloyds Bank which would also be putting up the shutters but for the beneficence of the taxpayer.

Revealed: The best time to invest for outstanding potential gains

What have these three in common? Simply, they are all selling 'me-too' products in a market that offers little if any growth in demand. They have been locked in fierce competition – and lost. This is what the droop in the 'S' curve represents.

You don't want to invest in companies at this late stage of the 'S' curve. You don't want to invest, either, in the early phase when money is being spent with no certainty of any return.

No. The time to invest is when demand is rising rapidly and the industry's pioneers are set to garner the rewards at the most profitable time of the product cycle.

Let me give you just one example of an industry that is at this point.

The field of medical diagnostics is sophisticated enough that it can now offer instant tests. There is a huge demand for them. The share price of one company in this emerging sector, Immunodiagnostic Systems (LON: IDH), has risen five-fold this year.

This is what can happen when you jump on the 'S' curve at the right moment. But there are plenty of other opportunities to be had in small, UK growth companies.

• This article was written by Tom Bulford for the free investment email The Penny Sleuth

Published in How to invest | More articles by Tom Bulford

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