The FTSE 100 index currently around 25% below its 2020 highs, and buying opportunities are beginning to emerge for long-term investors.
That said, picking the best stocks to buy is not an easy task at present. The coronavirus is having a huge impact on nearly every industry, making stock analysis far more challenging. If you’re buying stocks right now, here’s what you need to know.
Earnings will be hit hard
The first thing to understand about stock analysis right now is that price-to-earnings (P/E) ratios, both trailing and forecast, are not much use in many cases. This is because earnings – the denominator in the P/E ratio – in many sectors are likely to be decimated in the near term.
Take a stock like easyJet, for example. For FY2019, it generated earnings per share of 88.7p. We could plug this into a P/E ratio formula and get a trailing P/E figure of 6.6 (583p/88.7 = 6.6). Yet, in reality, this figure is quite meaningless. We know that earnings this year won’t be anywhere near that figure (all of its planes are now grounded!).
Similarly, we could put the consensus earnings forecast for FY2020 of 34.4p per share (it was 72.9p per share yesterday) into the P/E ratio formula to get a forward-looking P/E ratio of 16.9. Once again, this figure is going to be relatively meaningless. The reality is that City analysts have no idea what easyJet’s earnings will be, given the extreme travel restrictions.
As highly respected analyst Paul Scott at Stockopedia says: “Forecasts have gone out of the window – we haven’t got any sensible guidance yet on how companies might perform. Lots of companies are likely to be reporting huge losses this year, and may or may not survive.”
Of course, there are some sectors in which earnings should hold up relatively well. Here, P/E ratios could still be a useful form of analysis. However, in many sectors, near-term earnings are going to be hit hard, which means that P/E ratios are really not much use.
Dividends will be cut
The next thing investors need to understand is that dividend forecasts can’t be relied on. In the current environment, many companies are suspending their payouts in a bid to conserve cash.
In the last few weeks, we’ve seen dividend cuts from a whole host of FTSE 100 companies, including ITV, Whitbread,and WPP. I’m expecting more companies to cut their payouts in the weeks ahead.
To quote Scott again: “As so many companies are cancelling their divis, I think it is safest to assume that all shares are currently yielding nothing, unless there is some reason to believe otherwise.”
How to invest right now
So, what can investors do in this challenging environment?
Well, I think the best approach right now is to forget about P/E ratios and to an extent, dividend yields. Instead, focus on investing in high-quality companies that are likely to survive the economic downturn, but that have seen their share prices fall.
Ultimately, we’re in unchartered waters right now. The key, in my view, is to keep things simple and invest in resilient companies with a strong chance of survival.
