I’ve been banging on for years that there is more downside risk than upside potential with the big London-listed bank shares such as Barclays (LSE: BARC). I reckon many investors have been distracted by all the other issues that the banks have been working through since last decade’s credit crunch and have maybe taken their eyes off the big picture.
Lots of downside risk and little upside potential
And to me, the big picture and overriding issue with the banks is their inherent cyclicality. It looked to me like the rapid rebounding of banks’ share prices during 2009 was all that was worth playing for in terms of a cyclical rebound. My reasoning was that the stock market would likely thereafter compress the banks’ valuations as profits rose over the coming years, which would all drag on further share-price progress. Meanwhile, despite the capped upside, all of the cyclical downside risks would remain in place pending the next cyclical plunge.
And so, it has come to pass. But I can’t claim credit for dreaming up that working theory all by myself. I read it in a book called Beating the Street by legendary fund manager Peter Lynch. I’m glad I did, because his wisdom has helped me lock in profits by selling banking shares after they bounced back from the credit crunch and saved me a fortune in opportunity costs by keeping me out of banks such as Barclays ever since.
You can see how responsive the banks’ shares are to the downside at the merest suggestion of economic headwinds. During the current market weakness, you can bet your bottom dollar that the banks will be leading the charge lower. And one day their profits will crash too, their dividends will be cut, and if you are still holding the shares, you can wave ‘goodbye’ to at least half your capital – many bank shares plunged 95% or so in the last big crash around 2008.
The problem with banks, as I see it, is that they are not proper trading businesses at all, just facilitators of other firms’ businesses that provide the means of moving money around. As such, banks just skim a living from the enterprises of other businesses and individuals. So, if everyone else is doing well, the banks do well. If everyone else is struggling, the banks struggle — they are cyclical beasts to their very core.
Strong trading and growth potential
So, I’d avoid Barclays right now and go for a real business such as DiscoverIE Group (LSE: DSCV). The firm designs, manufactures and supplies customised electronics to industry, which is just the sort of business supplying useful stuff that I think looks set to do well in a new period of economic prosperity that we may experience from where we are now.
In today’s trading update it said that second-quarter trading has been “strong” and in line with the directors’ expectations. Sales in the first half rose 13% compared to the year before, 4% of that organically (suggesting strong customer engagement) and 9% from acquisitions. The order book is up 18% year-on-year. The directors said in the update that DiscoverIE has “a clear organic growth strategy and an active pipeline of acquisition opportunities”, which bodes well for further operational progress ahead, in my view. I think the stock is attractive.
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.