In the short space of hardly more than two months, the stock market has responded particularly to lockdown regulations imposed in response to the Covid-19 pandemic, with rather spectacular volatility. Many investors initially turned overly pessimistic, became extremely doubtful about their preferred investments, and experienced a significant weakening of their resolve to continue investing in growth assets such as shares and property.
It did not take long, however, for a surge of investor energy and optimism to return, which brought about a rather surprising recovery in the JSE All Share Index from a recent low of 37 963 on 19 March to a high of 54 722 on 5 June 2020. This may be deemed a rather irrationally exuberant response following the first steps in the easing of lockdowns by many countries.
Swings between over-optimism and over-pessimism are, however, well-known phenomena in the investment world.
In perhaps the best-known investment book of all time, The Intelligent Investor (first published in 1949), investment guru Benjamin Graham wrote “the intelligent investor is a realist who sells to optimists and buys from pessimists.” He often refers to “Mr Market”, a personification of the stock market as a whole.
Graham asks the reader to imagine they have a $1 000 stake in a business and that one of their partners, Mr Market, tells them every day what he thinks their stake is worth. Some days his idea of value appears “plausible and justified”. Other days Mr Market is so depressed he gives a ridiculously low price, or he is so excited he gives a ridiculously high price.
Graham goes on to explain that as long as one knows the real value of the underlying company one can buy when the price is low and sell when it is high. In his strategy known as value investing, investors buy stocks that appear cheap relative to the underlying company’s revenue and earnings, believing the stock price will rise as more people come to appreciate the true intrinsic value of the company.
At the time of writing, more than two-thirds of the companies listed on the local stock exchange trade at prices lower than that of a year ago. Many of them are cheaper than they were three years ago, with many even cheaper than five years ago.
While some of these companies deserve to trade at these low prices, many more appear cheap when compared to their perceived real value. In theory, once enough investors understand there’s a discrepancy between a stock’s current price and its intrinsic value, the share price should rise to match its perceived real worth.
While the defining quality of a value stock is trading at a price lower than what the underlying company’s performance would suggest, most value stocks also have other attractive attributes that make them appealing to investors. In most cases, value stocks are mature companies with strong balance sheets that have steady growth rates, stable revenues and consistent profitability enabling them to offer attractive dividend yields.
Investors who want to invest in risk assets, but who are hesitant to take on the risk associated with the general equity market, could consider a diversified portfolio of value stocks as an alternative to an investment in the general market.
While there’s no guarantee that the prices of apparently undervalued stocks won’t decline further, additional declines may be less probable and can be expected to be less substantial than that of typical growth-type stocks.
Investors should, however, be cautious not to get sucked into a value trap when buying shares that appear to be “cheap” or undervalued. Sometimes Mr Market is right, and the company is cheap for a good reason. Hence, if one’s analysis of the company missed a few vital issues, one could find oneself stuck with a company with a bleak future and a share that continues to disappoint.
Over the last three months we have seen the market swing between over-pessimism and over-optimism, providing investors in risk assets with a rather dizzying rollercoaster ride. These market swings can, however, provide wily investors with the opportunity to invest in quality companies at prices that show an attractive discount to intrinsic value.
To assist staying on course with your investments in such volatile times, don’t focus too much on short-term swings; rather focus on factors determining the longer-term value of the investments you are considering.Note: The information in this article does not constitute financial, tax, legal or investment advice, and the companies in the PSG Konsult Group do not guarantee its appropriateness or potential value. As individual needs and risk profiles differ, we recommend that you consult your qualified financial adviser if need be. PSG Wealth Financial Planning (Pty) Ltd is an authorised financial services provider (FSP 728).
* Werner Gerber is a Wealth Manager at PSG Wealth Hermanus.
