The clue is in the violent share price movements. The bad economy brings uncertainty, but uncertainty brings cheap shares. Do you fancy 50% off Marks & Spencer shares?
Recession today, recovery tomorrow. So goes the ‘usual’ economic cycle. But, and I know these are the five most dangerous investing words, maybe this time it is different.
Never before, in my 20 years of stock market investing, have I seen the entire global banking system come perilously close to collapse. Never before have I witnessed an economic contraction as fast and as severe as what we are seeing today.
As far as the stock market is concerned, never before have I seen share price movements of the scale we are witnessing now. On Monday alone, we saw one FTSE 100 company, Barclays (LSE: BARC), rise a quite astonishing 73%. On the same day, we saw another FTSE 100 company, plumbing group Wolseley (LSE: WOS), fall a portfolio-wrecking 30%.
These are no fly-by-night small companies. These are British institutions. There is no way, in normal times, the biggest and supposedly best of our companies should see their share prices move to such an extent.
Have A Punt And Get Lucky
But these are not normal times. How else do you explain such violent daily share price movements? I mean to say, are you telling me the underlying value of Barclays has increased by 73% in just one day? It’s madness.
You can look at it in 2 ways…
1) Given the highly uncertain economic outlook, no-one has a clue as to the true underlying value of many businesses. As a stock market investor, you can either have a punt, and perhaps get lucky as Barclays punters did today, or bail out of the stock market completely until economic conditions stabilise.
2) If you are prepared to look past the recession and ahead to some rosier times, there are some excellent companies selling at once-in-a-lifetime value prices.
So what do you do? First you have to take a view on the economy, and the profitability of companies.
First, the economy. Will it recover? Yes. When will it recover? Don’t know.
Next, company profitability. Will it recover? Yes. Will it recover to the levels of 2007 and 2008? For some companies, yes. For others, including some retailers and banks, possibly no.
Add it all up, mix all the variables, stir for 5 minutes, place in a round tin, bake at 200 degrees for 30 minutes, remove from oven and serve immediately, and what have you got? A recipe for uncertainty.
The One Great Investing Catch
It’s a well known fact that the stock market hates uncertainty. It hates uncertainty so much that it makes share prices go down.
It’s so much easier and better when you can see some nice steady growth ahead and can establish a decent estimate of a company’s true underlying value. If that underlying value is less than the value of the total company as determined by the stock market, you’ve got a buy.
But there is a catch.
Certainty requires a steady economy. It also means share prices are higher. At the beginning of last year you could have bought shares in Marks and Spencer (LSE: MKS) at 500p. At the time, based on their projected profits for 2008, you were paying about 12 times earnings for your M&S shares, and their earnings were projected to grow a further 10% odd. It seemed about right, because we thought we had certainty.
50% Off Marks & Spencer Shares
Fast forward to today. We can buy M&S shares at less than half the price they were about a year ago – around 225p today. That’s the price of uncertainty. Shares are on sale.
Or are they? M&S trades on 10 times their projected 2010 earnings. In this uncertain economic environment, it seems about right. But what if…
a) the economy recovers in 2010 or even 2011?
b) M&S’ profit margins revert back to their normal levels?
Under those scenarios, M&S shares today are cheap, and could quite conceivably double between now and the end of 2010. I don’t know about you, but right now, a 100% potential gain over 2 years sounds rather attractive, especially coming after what all our share portfolios have just been through.
The Guts To Buy
There are many Marks and Spencer-like scenarios out there in stock market land today. Today’s uncertainty offer the potential for out-sized returns in a relatively short period of time.
It takes guts to buy now. It takes faith to buy now. It takes a glass half full mentality to buy now. It also requires risk-taking. The longer the economy takes to recover, the more chance share prices will continue to fall, the more chance you have of incurring a permanent loss of capital, and the longer it will take for share prices to recover.
Because you are reading this article, I presume you are interested in stock market investing. So what’s it to be? Do you fancy grabbing a bargain today? Or do you wait for tomorrow, when the economy has recovered, and shares are again priced about right?
Maybe it is not different this time after all. Maybe it’s time to buy.
More: Five Large Shares To Take A Punt On | Time To Take A Punt On A Bank
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> Of the companies mentioned in this article, Bruce Jackson has a beneficial holding in Barclays.
