The UK stock market has been remarkably resilient in the face of today’s global crises. That’s great in one way. But it can also leave We investors scratching our heads a bit.
I find it harder than usual to distinguish the best-value companies from those with less promising outlooks. A rising tide lifts all boats, they say? The trouble is, it can obscure the ones that are really destined to be sinkers.
It reminds me of that famous quote from ace investor Benjamin Graham, which puzzled me when I first saw it. He said: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.“
He meant that in the short term, investors vote with their money, based on headlines, crowd trends, emotion… whatever drives their feelings on any given day. And it can take a longer time for underlying earnings prospects for companies to be weighed up and determine a sensible valuation.
Are these cheap?
As an example, are BP (LSE: BP.) shares a good investment now? I think it’s hard to tell. The BP share price is being driven by short-term oil prices. One day the stuff is up over $110 per barrel. Then the next day, Donald Trump reverses what he said the previous day, and oil is suddenly back below $100.
The political push behind oil and gas consumption of recent years also helps obscure the long-term outlook for oil. Renewable energy will surely have to come back into favour some day. And we’re already seeing the rise of a new generation of nuclear power plants emerging.
Now, I do see BP as a stock that long-term investors should seriously consider. I like its 4.5% forecast dividend yield, for one thing. But while politically-driven sentiment is clouding the outlook, my feeling for a rational valuation is obscured. A market shake-up, hopefully leading to more level-headed times, could help clarify that.
Tricky valuations
I mentioned nuclear power. And that brings me to Rolls-Royce Holdings (LSE: RR.). Its stunning recovery over the past few years took us all by storm. And those who saw it coming could easily be sitting on a five-year profit of over 1,100% today.
Again, this is another company I rate as worth consideration, even after that rise. But we’re surely looking at a defence premium in the share price here. And that’s in the midst of today’s Middle East military conflicts. On the other hand, the UK’s first nuclear plant based on Rolls-Royce small modular reactors has the go-ahead for work to begin.
But does this mean Rolls-Royce shares are worth a forecast price-to-earnings (P/E) ratio of over 35? And how will markets evaluate them when we’re in more peaceful times? Again, I really don’t know.
Calmer markets
While I do rate these two stocks as ones to consider, I think the main risk facing both is the same. It’s the current emotion-driven and headline-driven market sentiment. But I’m sure more rational times will return — even if it does need a stock market crash.
And a crash would mean cheaper shares all round anyway.
