If you acquired shares in private health insurer Medibank Private Ltd (ASX: MPL) during last year's initial public offering (IPO) you're currently sitting on a tidy paper profit and a return that is around 10% better than what the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) has achieved.
One of the many challenges investors face is overcoming a tendency to "anchor".
Anchoring can take many forms. For example, perhaps you bought into resource stocks at the height of the mining boom and unfortunately lost money. This experience could lead you to swear off buying another mining stock ever again – it's an understandable stance to take.
The similar scenario could have happened to investors who owned technology stocks at the turn of the century which soared to unbelievable heights before crashing back down to earth.
Unfortunately, in both instances deciding to never invest in a whole sector again because of a bad investment experience might mean you miss out on numerous profitable future opportunities. It could also mean you don't get to utilise valuable knowledge you have gained along the way!
Another area where anchoring can occur is with regards to a price level.
For example, identifying an attractive investment opportunity only to see the share price move higher before you purchase the stock can lead to a fixation of buying at that prior price level even though the investment merits may still be favourable at the higher price too.
The reverse of this situation can happen too. Consider Medibank Private for instance…
It's possible that many shareholders of the stock don't believe there is much upside in the stock from this point, perhaps some shareholders are not even sure what the stock is really worth.
What they probably do know however is: the price they paid for the stock ($2 a share), the price the shares are currently trading at (around $2.30), and the highest price the shares have reached since the IPO ($2.59).
With the share price trading on a forward price-to-earnings (PE) ratio in the vicinity of 18x the stock is perhaps not wildly expensive, but nor is it a bargain. At $2.59 that PE multiple would expand to around 20x.
Some shareholders may be quite happy owning Medibank Private at these levels, however, those that have identified better investment opportunities would arguably be well advised to not anchor to a higher price level before selling.
