You can leave your money in the bank or collect a dividend of 6%.
There's a bit more good news around these days than there was a few months ago. The global economy is stabilising and the recession has officially ended. Still, I expect economic growth to be relatively modest. We won't recover from the Great Recession in just a couple of months or quarters.
Just take a look at the recent outlook statements from Dairy Crest (LSE: DCG)…
"We remain cautious about the trading environment for 2010…"
and from BP (LSE: BP)…
"We expect to see the demand for oil rise in… 2010, reflecting a gradual restoration of global economic growth."
As if you need reminding, never before have we experienced a 'global financial crisis'. Never before have we come close to a truly global recession. There remains a huge amount of uncertainty around the economy -- some people think it will be all plain sailing from here, others think we're in for a double-dip recession.
What does all that mean for stock market investors?
Buy, Sell Or Hold Shares?
As usual, there are 3 options, buy, hold or sell.
It's clearly not rocket science. Yet many investors are trying to make the art of investing incredibly difficult and incredibly stressful. There is no doubting the month of October 2008 will go down in history as one of the most stressful investing months ever. The problem was, you never knew if the selling was ever going to end, and you never knew if your money was absolutely safe.
The early part of March 2009 wasn't much better either, with at one stage the FTSE 100 being down 22% in 2009, coming on top of 2008's awful 31% decline.
I'm Buying, And I'm Selling
Thankfully, it seems the very worst has passed, although investors should certainly not become complacent. So what should you do now?
Right now, I'm buying shares. I'm also selling. And I'm holding.
When buying, I'm increasingly looking for high-yielding, blue-chip shares. Many of these companies have not participated in the massive run-up that some of the lower-quality shares have enjoyed.
When selling, I'm taking some profits on some companies I consider to be fully valued. With the proceeds, I'm either keeping them in cash, patiently waiting for more buying opportunities, or looking to reinvest in the aforementioned blue chips.
Buying Into The Teeth Of Recession
I'm making these investment decisions in the full knowledge that the UK still has some way to go to dig its way out of this recession. In the words of BP, they expect the recovery from recession to be "slow and gradual."
The other option is to sell everything and go to cash -- at least my money would be safe there, and at least it couldn't go down in value. But compare the returns on cash versus the potential returns on stocks -- the base rate is at 0.5%, yet dividend yields on some solid FTSE 100 companies exceed 5%.
Buying Vodafone Is A No-Brainer
Shares are risky. You can lose some or all of your investment. To compensate for that risk, you require a higher return, a fair trade-off.
How does this sound for a fair trade-off? With its share price at 135p, mobile phone giant Vodafone (LSE: VOD) is the UK's 4th largest company and one of the FTSE 100's highest yielding stocks.
In fact, its prospective dividend yield is the 10th highest in the index of leading shares, ahead of other popular high yielders such as United Utilities (LSE: UU), J Sainsbury (LSE: SBRY) and Argos/Homebase owner Home Retail Group (LSE: HOME).
Vodafone's forward dividend yield is 6.1%. You can keep your cash in the bank earning around 2%, or you can by shares in Vodafone, earn a prospective dividend yield of 6.1%, and be also be exposed to the company's future growth.
Obviously there are risks. Vodafone carries a lot of debt. Growth is relatively anaemic as competition eats away at its market share in developed countries like the UK. The dividend cover is below 2, meaning should profits fall, the dividend could come under threat. Still, a P/E of around 9 gives investors some level of comfort on the valuation.
There are always risks. In the case of Vodafone, at this dividend yield and valuation, I'd suggest the risk is relatively minimal. Remember, share-price volatility has nothing to do with risk. If the market tanked 10%, it wouldn't make Vodafone a riskier investment, all things else being equal.
Hundreds Of Other Cheap Stocks
For every Vodafone, there are many other cheap companies. I counted 17 companies in the FTSE 100 alone trading on forward P/E ratios of less than 10, the equivalent of a 10% earnings yield or better. Many of them also trade on dividend yields above 5%.
Not every company or every sector is a buy at the moment. For example, I'm steering clear of retailers and banks, having completely sold out of the latter sector at higher share prices than currently prevail.
The opportunity is clear. In some cases, like Vodafone, the risk/reward ratio appears to be in your favour. The alternative is cash. Over to you.
More on the economy and the markets:
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> This article was first published on 10 November 2008. It has been updated.
