Stock market investing need not be complicated. By asking 2 simple questions, university student Jody proves just how easy it can be.
I was travelling on the train recently when I bumped into a girlfriend of a friend. 20-year old Jody was making the one hour train ride to go to her daily university classes.
About 30 minutes into the journey, we started talking about what I do for a living. I explained to Jody that I write about the stock market, and have a keen interest in shares.
Jody knew the stock market had been through a tough patch. It has been in the news, and she’d read about how some people had lost fortunes in the great crash of 2008. After I explained my simple version of how it all happened – too much debt, too much spending, over-inflated house prices, questionable lending by the banks, over-valued share prices, recession – she asked two simple questions…
If people were happy to buy shares last year, why aren’t they buying more now they are 30% cheaper? Surely cheaper is better, isn’t it?
They are great questions. One reason people who bought last year but are not buying now is that in early 2008, most of us didn’t know the global economy was about to enter a deep recession. In a recession, profits fall, and although share prices have already fallen, they are not necessarily cheap just because they have fallen by 30%, 40%, 50% or more.
Avoid With A Barge Pole
For example, take a look at this list of big fallers over the past 12 months.
| Company | Recent Share Price | 1 Year Share Price Fall | Forward P/E | Forward Dividend Yield |
|---|
| Barratt Developments (LSE: BDEV) | 93p | 73% | (7) | 0% |
| Royal Bank of Scotland (LSE: RBS) | 51p | 87% | 7 | 0% |
| DSG International (LSE: DSGI) | 21p | 71% | 9 | 0% |
| Yell Group (LSE: YELL) | 54p | 84% | 2 | 0% |
| Punch Taverns (LSE: PUB) | 58p | 98% | 1 | 0% |
Are those companies cheap? Possibly. But they are all facing substantial headwinds, whether that is because of the recession, because of uncertainty, because they are companies in permanent decline, or because they have serious levels of debt. Personally, I wouldn’t trust any of the forward price to earnings (P/E) ratios and wouldn’t be touching any of them with a barge pole, whatever the valuation.
A Risk Averse Nation Of Investors
Back to Jody’s question. Another reason why people aren’t buying shares today is because we’ve all suddenly become risk averse.
If we are risk averse because we fear for our jobs, and we want to build up a buffer of savings should the dreaded P45 land on our desks, that’s completely understandable.
If we are risk averse because we fear the worst for the global economy, and we expect share prices to fall significantly from here, that too is understandable. That said, we don’t want try to time the market, because as we all know, timing the market is virtually impossible.
But if we are risk averse simply because we’ve lost money, and are fearful of losing more money, we’re a) potentially going to fall for the biggest investing mistake of all time, of buying high and selling low and/or b) missing out on some compelling long-term bargains.
Cheap Is Good
Jody, in all her naivety, hit the nail on the head. Cheaper is better. Would you rather buy Tesco (LSE: TSCO) shares at the 472p they traded last year, or at the 352p they trade today? How about Royal Dutch Shell (LSE: RDSB)? Would you rather buy them at 2212p or today’s 1734p?
Obviously the investing game has changed between last year and this year. In the case of Tesco, sales growth is slowing. In the case of Shell, the oil price is down significantly from last year. In the case of the economy, it’s in recession now, and expected to stay that way for most of the rest of this year, and probably into 2010.
Yet you could argue most of the bad news, including a long recession, is already factored into share prices of companies like Tesco and Shell. And when you compare their dividend yields with that of base interest rates, shares look even more attractive.
Keep It Simple Stupid
So Jody, in answer to your simple questions, people who bought shares last year should be buying shares this year, and yes, cheaper is better. But, as ever with the stock market, there are always other considerations to take into account, like individual company valuation and competitive advantage, the economy and interest rates.
As an aside, it’s exactly these factors that Maynard Paton, over at our premium stock picking service Champion Shares, spends his time looking at. Take out a free 30-day trial today and check out his very latest share recommendations.
But I digress. My one hour train journey with Jody was enlightening. Stock market investing need not be complicated. If you ask Jody, she would sum it up as “Buy shares when they are cheap, and sell them when they are expensive.” Many companies are cheap today. I’m still selectively buying. If Jody had the cash, she’d be buying too. Her day will come.
More: My 5 Stock Market Resolutions For 2009
> Bruce Jackson doesn’t have an interest in any of the companies mentioned in this article.
