For many shares in the UK and stocks in the US, shareholders have been seeing falling prices. And the common theme is most of those plunging names had previously been good-performing stocks for investors.
In the UK, I’m talking about companies such as Experian, the global information services business. The stock has plunged by around 31% since the beginning of 2022. But at 2,805p, it’s still up by about 16% over the past year.
Quality businesses with high valuations
And there’s nothing wrong with Experian. The company runs an impressive and growing business and scores well against quality indicators. But the share price had staged a multi-year bull run. And the almost inevitable consequence of that has been a high valuation.
Even now, the forward-looking earnings multiple stands near 27. And that’s when it’s been set against modest double-digit percentage anticipated growth in earnings.
Similar examples include chemicals company Croda International, technology outfit Halma and Spirax-Sarco Engineering, among many others. They are all great businesses with promising prospects. And I’d love to one day have their stocks in my portfolio. But my read of the market is it may not have finished marking down valuations to better fit the potential of a business.
Warren Buffett, for example, likes to buy wonderful businesses when they are selling at fair prices. And that often means he ends up buying stocks during troubled economic times, or when the wider stock market has been crashing.
But I don’t believe Buffett would judge valuations to be low enough to buy the decent companies I’ve mentioned here. Therefore, they are all going on my watchlist waiting for a better entry point, despite the recent share price falls.
Retraces can move a long way
US super-trader Mark Minervini has what he calls a 50/80 rule. He reckons when a leading stock makes a major top, there’s a 50% chance it will drop 80% and an 80% chance it will drop 50%. And the average decline of a former leader is more than 70% peak to trough.
Of course, he’s not talking about the performance of the underlying businesses. In many cases, they can keep growing and performing well whatever the share price is doing. But when valuations become stretched, stocks really can sometimes retrace their gains by scary percentages.
I wouldn’t base my entire investment career on Minervini’s observation. But it is food for thought. And it’s keeping me cautious regarding these fallen leader stocks for the time being. Meanwhile, another piece of market wisdom asserts that the leading stocks of the previous market rally are often replaced by new winners in the next bull run.
Lately, I’ve noticed that stocks scoring well on value attributes have burst into life in many cases. So it looks like we could be seeing a mass investor rotation from high-priced growth and tech stocks into companies with strong value characteristics.
And my guess is the next big bull run will likely be led by such value plays. So with a £2,000 lump sum to invest now, I’d look for stocks scoring well against traditional value indicators.
