It seems scary when stock markets are plunging, such as right now. But if you don’t invest when share prices are lower, when should you invest?
I admit it always feels easier to commit money to shares when stock prices are riding high and the main indices such as the FTSE 100 are going up. But when we are in the middle of a bull run, sometimes share prices can run ahead of themselves, which tends to drive up valuations.
Of course, we judge valuations by looking at indicators such as the price-to-earnings (P/E) ratio, the price-to-book (or asset) value, and the level of the dividend yield. And if these figures are high, or low when it comes to the dividend yield, it could be that we are paying a high price for our little stake in the underlying business represented by our shares. And if the price is high, one of the big dangers is that the stock market will drive valuations down again, which it is likely to achieve by marking share prices down.
That’s what we are seeing now. The market is driving share prices down and valuations are becoming lower. That’s a great situation if you are a potential buyer of shares because it means you’ll have a chance to buy shares that are valuing their underlying businesses lower than they were. But falling prices are not so great if you already hold shares because your capital will decline.
So, rather than buying shares when share prices and valuations are up it makes a great deal of sense to buy when they are down, but as I mentioned earlier, it’s scary. Indeed, shares have tumbled because the market is worried about something. I think the falling stock market in the US is a big driver of the recent plunge because the London market ‘always’ follows the US market down with the big moves. But here’s an interesting point. The US stock market has looked more highly valued than the London market for some time. Some believe the US market has been over-valued. So perhaps the recent falls in London are not as well justified as those across the pond, which suggests that we could be near the bottom of the correction here in Britain.
On top of that, the convoluted Brexit process must be keeping a lid on the progress of many UK share prices because stock markets and businesses hate uncertainty more than they hate anything else. But I think the uncertainty about Brexit will reduce by degrees as we move along from here. Once we know where we are going with Brexit, my guess is that we’ll see a relief rally in shares.
So now’s the time to think seriously about investing in shares for the long haul. There are many decent firms available in the FTSE 100 alone, paying good dividend yields and with good prospects, so you could go for one of those. But if you have just £1,000 to invest right now, why not put it in a FTSE 100 (INDEXFTSE: UKX) tracker fund, which will give you instant diversity across many firms and all for a low cost?
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.