Is this the right time to invest or not?

28th Dec '18 by Meldrew

16 comments 2445 reads

I have recently received a bit of spare cash that I would like to invest in shares. However, I am put off by the uncertainties caused by Brexit and Donald Trump and what seems to be a looming bear market. I have decided to wait and see what happens. I am filling in the time trying create an investment plan using the data and ideas available in Stockopedia. I have targets, possibly unrealistic, of creating an income stream of between 3%-5% net and growth of about 20%-25% pa. by investing on the UK, USA and European markets, using Ben Graham's deep value formula to identify appropriate stocks.

I already have a bit of experience in investing but my success has been mixed to say the least. Probably because I have never really had a proper strategy. I am now trying to correct that.

I just wondered if anyone had any thoughts on what I am planning and to what extent others share my concerns about investing just now.

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Rusty2

28th Dec '18

I think you are right to be concerned, I would wait until at least March, see what happens with Brexit first. I would be wary of deep value, if we do have a recession then they could get a lot deeper value. The Ben Graham Deep Value screen has not performed at all well this year. I would set up some folios on here, you can have 10 different ones. Try a momentum screen.

jonesj

Income of 3-5% net PLUS growth of 20-25% would be performing some way ahead of Warren Buffet.

Some background reading might be a good starting point.

AnonymousUser353071

If you have cash, the bear-market we are facing right now is a very good opportunity to get in the market. There are a lot of stocks, valued at an attractive price. Average investors lik us aren't good at market timing. So yes, maybe the market will come down even more percentage. But what is the probability? Therefore a good asset allocation is more important than the perfect market timing. And you need a longterm strategy that you understand and stick to this. I myself collected some cash the last months and stood at the sideline. But with the beginning of 2019 I will build up some positions.
I wish you and every other investor here at Stocko much success!

jonno

Leaving aside your investment aspirations, there are many stock market truisms; perhaps two of the most important are:

“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” (John Kenneth Galbraith).

“People that think they can predict the short-term movement of the stock market — or listen to other people who talk about (timing the market) — they are making a big mistake,” (Warren Buffet).

My own approach that is common to many investors is to avoid heavily indebted companies and seek to invest in those that have good ROCE and free cash flow with a decent operating margin.

There are too may good books on investing to mention, but if you have a chance view the presentation by Stephen English at Mello this summer. It can be found under the tab "Friends - Mello" on the PI World website. Interviews/presentations with/by Leon Boros are also available at PI World and are very informative. Finally Phil Oakley has written some very good articles, one of his most recent "Share prices contain valuable information: here's how to use it" is available at Investors Chronicle on-line, if you can access it and well worth worth a read.

Good luck with whatever you decide.

timarr

29th Dec '18

My own approach that is common to many investors is to avoid heavily indebted companies and seek to invest in those that have good ROCE and free cash flow with a decent operating margin.

Fine advice indeed. I'd add that you need to look at overall valuation - a high quality stock will often trade at an excessive multiple of earnings which often - although not always - means that you don't get the kind of investment performance you'd hope for. Fevertree Drinks (LON:FEVR) for instance is a very fine company but even after a significant fall it's still trading at 90 times its operational cash flow: it could get bought by someone of course, but you'd have to very optimistic to think it can grow into that valuation quickly.

Personally I look for companies at a market cap of less than 12 times operating cash flow - but that's in the context of high free cash flow relative to earnings as well as low debt and high-ish ROCE. As you might expect there's quite a lot of interesting stuff finally starting to pop up that meet these criteria.

The thing about this type of approach is that it gives you a built-in margin of safety - you can't protect against a general market slide, but companies with these kinds of metrics are unlikely to fail totally, and on a two or three year view buying quality companies at reasonable valuations is likely to work out ok regardless of everything else.

But, of course, you have to diversify. Any individual company can have something go catastrophically wrong, it's diversification that protects you. As a rule of thumb assume any individual holding can go bust at any time and see how you feel about that - if you can cope with losing 5% of your portfolio valuation instantaneously then you can target 20 equal weighted holdings. Less than that is probably unwise for an inexperienced investor.

You might note that yield doesn't get factored into the metrics above. As it happens many of the companies popping up on these screens are yielding more than 5%, some a lot more. That's unusual, but tells us something interesting about the market. Either it's pricing in a significant fall in earnings or we're seeing a bout of irrational depression due to the high levels of current uncertainty.

Either way, we're in for an interesting year!

Hi timarr

Spot on about overall valuation. This was the central theme of Phil Oakley's article "Share prices contain valuable information: here's how to use it" in which he talks about "Earnings Power Value". He cites the definition of EPV taken from Bruce Greenwald’s book, Value Investing: From Graham to Buffett and Beyond. "as the value of a company if its operating or trading profits stay the same forever."

You mentioned Fevertree, Phil uses ASOS as an example and concludes that its share price, even after the recent profit warning is factoring in significant future profits growth. All well and good if it materialises, but there is no margin for error.

Hi jonno

That's interesting. A quick back of fag packet calculation suggests that Fevertree Drinks (LON:FEVR) is trading at 4 times its EPV - i.e. 75% of the price is based on assumptions about future growth - while Next (LON:NXT) is trading at a 30% discount to a fair price.

Now Fevertree is growing at 20% plus per annum while Next is struggling to maintain its profits so you can see how growth expectations are impacting valuations. However, one of our main psychological traits is to extrapolate current conditions infinitely forward so usually we overestimate and overpay for future growth, while undervaluing lower growth companies.

Phil Arnott's research suggests that we are very good at identifying high growth companies, but consistently pay twice what they're worth, while simultaneously undervaluing low growth companies. This is is partially why value investing works, eventually.

And, of course, high growth, highly valued companies are much more vulnerable to a setback than lower growth, undervalued companies. The former - like ASOS - will get hammered if they fail to maintain profit growth.

Still, you pays your money and you takes your choice. Personally this feels more like value investing territory than momentum trading time to me, but only hindsight will tell us for sure, eventually.

aflash

creating an income stream of between 3%-5% net

Meldrew,

Other posters will agree that it is not a good plan to have an income target from shares. A 3% yield on purchase becomes much higher when you are carrying a 25% capital loss but even if you buy some more will never compensate and the dividend may be cut.

In the Battle for Investment Survival Gerald Loeb advises to never buy for income and to aim to double your money just to have a chance of retaining your capital.

Meldrew

30th Dec '18

Thank you all very much for your advice. I greatly appreciate it.

I've read through all your comments and, among your other helpful advice, get the clear message that my initial ideas were not likely to achieve my objectives and I also need to cut back on my ambitions for both income and growth. I am taking all your advice on board and will follow it all up with further reading.

At the moment I have a very small portfolio that consists of BAE, Carrs, Fevertree, GAW, Next, Plus500, PRU and Sosandar, Sosandar is my biggest holding. Each is in there for a different reason which is often little more than my hope and optimism. All except Sosandar pay a dividend. There is no real structure to it. All have been hit by recent events.

I hope to build up a portfolio of about 20 companies that might include some of those I already hold.

It is back to the drawing board for me but this time with some fresh ideas.

Many thanks everyone.

Although that's probably true for the OP it's not always the case.

For instance, if you're in retirement mode then what matters is a consistent income and protection against inflation. If you have the temperament to cope with the volatility then dividend paying stocks are an excellent way of achieving that.

Of course, at that point you're far less concerned about overall capital value so fluctuations in overall valuations are less important than the maintenance of a consistent income stream. Even there, of course, you need a margin of safety, but dividends are less variable than earnings as companies are reluctant to cut them unless they're desperate.

There are also high yield strategies which use dividends as a signal of undervaluation and therefore likely capital appreciation. So, as a general statement, I don't think ignoring dividends is always a valid strategy.

However, on the limited information given by the OP it's not immediately obvious that he should be focusing on income and capital appreciation as separate components. At the start of an investing career what usually matters is total return, it doesn't really matter how it's arrived at.

timarr

Maddox

Hi Meldrew,

Firstly, good luck with your endeavours. Yes in theory, the best time to invest has been when everyone else is hiding under the bed. However, no one can forecast the future so whether this is the best time to invest or not is a judgement call. However, it is the only time when you can find quality companies at reasonable prices. But, it is very important to take a risk-averse stance, and specifically avoid companies with debt.

You mention that you are looking to follow a Deep Value approach. I'd point you towards Prof. Glen Arnold's key note presentation on this topic at Mello London 2018 https://video.com/ondemand/mellolondon2018. His view is that this investment strategy, far from being over exploited, is still viable and capable of producing impressive results. As with all investment approaches it is better to find one that suits your own psychology otherwise it's very difficult to stick with it. With Deep Value the companies you find will be out of favour with Mr Market, probably lack research coverage and have only a few followers. You will therefore need to do your own detailed research into confirmation of value and look for the underlying causes for its poor market perception. If these features appeal to you then it might be the right approach for you.

Very best of luck and hope you will let us know how you get on.

But Fevertree Drinks (LON:FEVR) PEG is lower than Next (LON:NXT). Fevertree Drinks (LON:FEVR) I believe has beaten all their forecasts. The last update they were up about +40%, Next (LON:NXT) was -1%. Why invest in companies that profits are falling or are flat and giving out profit warnings? Yes if Fevertree Drinks (LON:FEVR) don't beat their forecasts then they will fall further but they are nearly 46% down already, yet EPS forecasts are rising, does that make sense? Also they maybe better placed than a high street retailer if there is a downturn next year.

Yes timarr it was a tip of the iceberg comment.

Had I expanded it would have been to say that a company's ability to grow dividends was more important than the yield at time of analysis.

Then in the case of utilities and bond-proxies it is more their ability to maintain dividends.

More than that in my own case I trade around the ex-dividend date, buying just before and selling just after, often picking up a good yield without capital loss. However it strays from the question asked. I have all day, he may not.

We now know a bit more about meldrew 's portfolio but he should tell us whether all his income needs are met before dolling out any more advice.

Read the book I mentionned. Loeb survived the 1929 crash and Great Depression but the advice is pertinent today.

skinner66

agree with posts brave to invest now even if cheap. depends if next year goes bad so sort gamble. buy cheap now. or wait till see what happens and maybe pay bit more but won't get fingers burnt,,im happy playing my own game on ftse/dow/dax,, banking few pounds each day is making up for my shares,

31st Dec '18

Yes if Fevertree Drinks (LON:FEVR) don't beat their forecasts then they will fall further but they are nearly 46% down already, yet EPS forecasts are rising, does that make sense?

Of course Fevertree's fall makes sense in the face of rising EPS forecasts - even at these levels it would normally be considered highly expensive, and it's fallen 40% from its peak. Its forecast PE is nearly 40, even now. And PEG isn't relevant for high or low growth stocks - it breaks down at the ends of the range.

But the debate here isn't about absolute valuation, it's about margin of safety. If Fevertree fails to hit its ambitious targets an investor would be left nursing a very nasty loss whereas the opportunity for a significant gain is limited by the fact it's already expensive. On the other hand Next is cheap - there are good reasons for that, but even if it fails to hit its targets it's unlikely to fall significantly and would probably recover reasonably quickly while generating a nice dividend and continuing to buy back its shares.

To put this into perspective, Fevertree currently trades at 89 times its operating cash flow, Next at 11 times. Basically if neither company grows its earnings Next will take less than 11 years to generate earnings that cover its market capitalisation, Fevertree will take 89 years.

Of course, Fevertree is growing its earnings - but they will have to churn out 40% growth in earnings every year for the next decade to match Next in this respect. Not impossible, but very, very unlikely.

Basically I can make a good case for buying Next as a safe haven for my capital in uncertain times. To come up with a similar case for Fevertree I have to make some heroic assumptions: in reality the share price would have to fall nearly 80% before I'd even consider investing, and even then I'd think I was overpaying.

This is the beauty of markets - different people have different perspectives and different objectives. But I do wonder if the low interest rate and momentum driven markets of the past few years have desensitised investors to the dangers of high valuations based on earnings forecasts. As we saw with ASOS (LON:ASC) with a highly rated stock it only takes a single stumble to see billions wiped off valuations. When market conditions change investors that don't adapt quickly are likely to end up nursing very painful losses.

Well I won't be touching any UK high street retailers for a while, I sold all of mine last year or early this year, I think things are going to get worse, they are already struggling and we are not even in a recession yet. Anyway I think there are safer havens. Next (LON:NXT) also have quite a bit of debt. I have held Next (LON:NXT) a few years ago, people then were saying they were good value, glad I sold out. Of the high street retailers I prefer £JD.

Is this the right time to invest or not?

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Meldrew

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