I often wish that the world of shares could be as flat as the Karoo, so that we could look into the future – not just a day or two ahead, but years into the future, to see the levels at which shares would be trading at by then. Wouldn’t that make investment management so much easier? Unfortunately, we don’t know what share prices will be tomorrow or next year, so we have to rely on other aids.
As with most investment opinions, investors often disagree about the best strategy when buying and selling shares. Some prefer to look at the flat Karoo through a telescope so they can see well into the future. They are more than willing to buy shares and wait patiently for good returns. Their reasons for buying shares are never speculative, and they are not worried about short-term fluctuations in the market. Other investors prefer to look at the market through a microscope, believing that being very active holds the key to good returns.
Shares are bought with the intention of generating quick returns, as these investors believe that they will be able to beat the market over the long-term.
Following the recent decline in our market, I decided to take a look at the market through both a telescope and under a microscope.
The Telescope investor
These investors buy shares and see them as good long-term investments. They aren’t bothered by short term fluctuations as they simply don’t monitor the market on a day-to-day basis. They select shares that progress over a longer period, usually about five to ten years, that should outperform risk-free investments like the money market.
Poor market conditions, therefore, offer these investors the opportunity to increase their market exposure at more reasonable prices.
Consider share performance over the past 35 years (since February 1983), broken down into one-,
two-, five- and ten-year investment terms. You will see that although your returns (Graph 1) might have been much higher over a one- or two-year period, you could also have experienced more negative years.
When looking at shares over a five- to ten-year period, however, total returns tended to be more stable in the region of 13.5% per year (excluding dividends).
What’s also interesting, is the fact that if you had monitored your shares over a five-year period or longer, you never would have experienced negative returns over the entire 35-year period. Take note: This includes at least three big corrections in the market.
The Microscope investor
The microscope strategy isn’t entirely unsuccessful. It can actually be applied quite effectively. Firstly, you can practice the importance of good market timing and secondly, you can use this strategy to try and identify overreactions in the market.
When looking at the market’s price earnings ratio (P/E), which gives an indication of how much investors are willing to pay for exposure to the market, over the past 35 years, it would seem as though we are still trading at levels that would have been considered expensive in the past.
The expected consensus market growth rate isn’t negative and growth of around 16.5% is expected over the next 12 months. This will allow the P/E ratio to trade at around 20 times, if the market remains at current levels.
If we compare this to the long-term average of 14.8 times, the market still seems to lean towards the expensive side. Given the focus on P/E levels, the microscope investor probably won’t be too worried right now about sitting on cash, while waiting for the market to become cheaper again before investing. In the past, I have argued that focusing on overall market levels can be deceptive and that P/Es can hide as much as they conceal.
Moreover, the danger here is that earnings are linked to interest rates that are sitting at extremely low levels worldwide that continue to surprise on the positive side. This is another factor that should be examined under a microscope in the months to come.
I believe that investors looking for bargains may very well find a good investment opportunity here and there. But when it comes to investing in shares, I will always recommend a longer-term approach in which you shouldn’t be too worried about short-term fluctuations – in other words, rather look into the market’s future through a telescope.
The opinions expressed in this document are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice. This is intended as general information and does not form part of any financial, tax, legal or investment related advice. Although the utmost care has been taken in the research and preparation of this blog, no responsibility can be taken for actions taken based on the information contained in this blog. Since individual needs and risk profiles differ, it is always advisable to consult a qualified financial adviser before taking action.