The economic outlook is a bit murky right now. There are still many uncertainties surrounding the course of the coronavirus pandemic. And the UK has still to get comfortable in its position outside the European Union.
The stock market rally has started
However, against that background, many shares have already been recovering from their lows of last spring. But when the outlook seems so uncertain, perhaps the last thing many people feel like doing is buying shares. However, looking beyond near-term concerns, conditions may improve. And when they do, businesses will likely flourish again and their share prices could be much higher.
One of the things that drives share prices is company earnings. Shares tend to value businesses with reference to their profits or their potential to make profits in the future. So, when an economic shock like the coronavirus comes along, many companies’ earnings plunge. And their share prices fall with them. And the anticipation of better trading ahead is one reason that many share prices are rising again now.
Another driver of share prices is the valuation multiples the market applies to companies. And the valuation tends to increase or decrease in step with the rate of earnings growth. So, a company achieving an annual growth rate in earnings of, say, 2% will tend to have a smaller multiple than one achieving 20%.
And those twin share-price drivers will likely move the stock market much higher before the economic sunshine is obvious again. That’s because the stock market is always looking around six months ahead of the reality on the ground. And six months from now, the coronavirus pandemic may not look like as big a crisis as it does now, for example.
Choosing quality at an attractive price
So, maybe it really is a good time to go shopping for the shares of high-quality businesses right now. If we wait for economic conditions to look rosy again it could be too late to pick up a good stock deal by nailing down a keen valuation. And historically, stock market plunges have always been followed by a recovery and a new bull market. Right now, my assumption is the stock market rally we’ve already seen may endure for years.
Of course, stock markets and individual share prices are notorious for not moving straight up. They wiggle up and down within a longer-term trend. Just as progress in underlying businesses is often a case of two steps forward and one back. So, it’s possible after buying shares or share funds we could see short-term losses in our share-trading account. But I’d be keen to invest £7,000 right now and I’d aim to hold on to my investments for at least seven years.
Over longer periods, short-term dips will often be forgotten. If I choose my shares carefully and make sure they are backed by high-quality growing businesses, my returns could be worth having over the years that follow. And that’s especially true if I buy when valuations are attractive. For example, right now I’d be keen to spread a £7,000 investment between shares such as pharmaceutical giant GlaxoSmithKline (LSE: GSK), soft drinks supplier Britvic (LSE: BVIC) and business software company Sage (LSE: SGE).
