... and they've created today's ugly market.
This stock market is ugly.
Good stocks are being dragged down with the bad. At times, selling has appeared totally indiscriminate. Many smaller-company shares in particular have been hammered, often for no apparent reason.
But wait a minute. There is a reason.
The global economy is in the process of de-leveraging. Debt is a dirty four-letter word. Risk is the other dirty four-letter word.
Combine the two together, and we get one of the most difficult stock markets I've experienced in my 20 years of investing. The last time I saw the market in such a bad mood was in the early months of 2003, culminating in the FTSE 100 bottoming in March 2003 at 3,287.
The debt markets have virtually seized up, as few institutions are willing or even able to lend money. Investors are deserting companies with high levels of debt -- such as Debenhams (LSE: DEB) and Yell Group (LSE: YELL) -- in their droves.
Then there's the host of small mining companies that have been hit by the double whammy of recently falling commodity prices and tight credit markets, meaning they will struggle to raise the huge amounts of money required to take them from small-scale explorers to producers. I predict many of these companies will become cash shells in the next few years, but that’s another story.
Where Has All The Private Equity Gone?
It wasn't too long ago -- about twelve months to be more accurate -- when many investors seemingly lost sight of risk. It didn't matter if a company had high debt, because interest rates were low, capital was easy to raise, highly leveraged acquisitions were the order of the day, and private-equity raiders lurked at every corner.
The housing market was going along swimmingly, rising inexorably even in the face of record low levels of affordability. Buy-to-let investors confidently asserted property never went down and was always a great investment. Twelve months later, they now know different.
Investors were willing to pay up for high growth companies. Take orthopaedic device company Corin Group (LSE: CRG) for example. Last year its shares peaked at 640p as investors became enamoured with its future prospects. At that share price, they traded on a historical price to earnings (P/E) ratio of over 100.
Fast forward to today and Corin shares are around 125p, a fall of over 80% in around 12 months. Ouch.
I could reel off any number of what I call "concept stocks" that have come a cropper, companies such as biodiesel outfit D1 Oils (LSE: DOO), down 90% from its 2007 peak, and electric vehicle company Tanfield Group (LSE: TAN), down more than 95% from its 2007 peak.
Risk is back.
These Stocks Have Been Unfairly Trashed
Of course, not every company whose share price has been trashed deserves to have had it trashed. There are companies such as bread and cake maker Finsbury Food Group (LSE: FIF), whose shares have plummeted 66% from their 2007 peak, yet the firm is still growing and, at 40p a share, is valued on a forecast dividend yield of almost 6% and a forecast P/E of below 4. Perhaps Finsbury's net debt of £43 million is to blame -- it’s that dirty four-letter word again.
Then there’s building and maintenance services company ROK (LSE: ROK), whose shares have fallen 65% from their 2007 peak. This business has very modest levels of debt, is forecast to grow at double digit rates, yet is valued on a forward P/E of 6 and a forward dividend yield of 4.9% at 80p a share. Perhaps the fact that it operates in the property sector is to blame -- property is seen as a very risky business these days.
No Shortage Of Cheap, Growing Companies
If nothing else, the current stock market is giving investors a well needed wake-up call…
• It has reminded people that if you are paying a high price for future growth, there’s an element of risk involved.
• It has reminded people that share prices can go down as well as up.
• It has reminded people that share prices can overshoot any level of rationality on the way up and on the way down.
Risky and debt-ridden shares are right out of favour now. They'll likely stay out of favour for some time. It's a timely reminder of the need to avoid speculation and to concentrate on buying and holding quality companies for the long term.
It's a great lesson to us all, but one which I'm sure many will forget come the next raging bull market.
In the meantime, I'm continuing to hunt for cheap, high-quality, growing companies operating in favourable sectors and with little or no debt. The great thing about this market is there’s no shortage of candidates. But that’s a story for another day.
Happy investing.
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> Bruce Jackson does not have an interest in any of the companies mentioned in this article.
