You don’t have to look far to find someone predicting a stock market crash is just around the corner. Many commentators are suggesting we’re due another crash because it’s been 10 years since the last one, in 2009.
There’s some truth in this. For example, the market crashed in 1987, 2000 and 2008. However, we also saw falls of between 10% and 20% in 2011, 2016 and 2018, for example. Are we really due for a crash? I’m not so sure. In order to understand the state of the market, I think we need to take a broader view of companies’ valuation and their financial health.
Does the FTSE 100 look expensive?
If the index looked very expensive, that might discourage me from buying. Overpaying for investments is one of the easiest ways to lose money.
Is the FTSE 100 expensive today? At the time of writing, the big-cap index was trading on 14.6 times earnings, with a dividend yield of 4.6%. Dividend cover looks okay to me, at 1.5 times earnings. Based in these numbers, I’d say the index looks decent value.
What if earnings crash?
The FTSE’s valuation looks reasonable, but are these profits sustainable? Are we heading for an earnings crash which would make the index look much more expensive? This is a more difficult question. It’s probably fair to say some of the larger companies in the index face a challenging outlook.
For example, tobacco stocks are under pressure as investors are concerned about falling smoking rates and heavy debt loads. Big oil and gas stocks such as Shell and BP are facing pressure to explain how they’ll adapt to a lower carbon future.
In a world of ultra-low interest rates, banks are finding it hard to maintain attractive profit margins. Although defensive consumer stocks such as Unilever and Diageo are generating record profits, such firms already trade at quite steep valuations. Any failure to deliver could see ratings fall.
As you can see, there are reasons to be cautious. But that’s very often the case. Investing always carries risk and uncertainty. Although there are some individual stocks I would avoid, I still think the FTSE 100 index looks an attractive investment overall.
What about the economy?
More than half of all revenue reported by FTSE 100 firms comes from outside the UK. So risks, such as the US-China trade war, are relevant to FTSE investors. Similarly, the health of major EU economies is worth considering, not just that of the UK.
The economic news seems to be mixed at the moment. Today, I see reports US and German manufacturing slowed in September. At home, UK retailers have reported the worst September since the mid-1990s. Are we headed for a recession? Perhaps.
Hedge fund billionaire Ray Dalio once said: “He who lives by the crystal ball will eat shattered glass.” I see this as a suggestion that predicting the future is dangerous and unwise.
My plan is simply to invest in companies with strong finances and attractive valuations. As a long-term investor, I’m confident good companies will survive and prosper. By drip-feeding money into the market each month, I hope to pick up some cheap stocks next time the market crashes.
In the meantime, I collect my dividends and profit from any market gains.
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Roland Head owns shares of Royal Dutch Shell B. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended Diageo. 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.