As global markets log some of their sharpest falls in history amid the coronavirus pandemic, some investors have been taking advantage of rock-bottom prices by buying certain stocks.
Major stock markets have been see-sawing for weeks as market participants buy and sell on the ever-changing news flow. The drops have spurred some investors on online trading platforms to attempt to “buy the bottom.”
Major stock markets have been see-sawing for weeks as market participants buy and sell on the ever-changing news flow.
Data from AJ Bell, a UK-based online investment platform and stockbroking serve provider, showed that purchase volume of securities in March is three times greater than sales.
Rival platform Interactive Investor too said that more than two-fifths of its users were increasing their stock market exposure, according to a poll of 2,295 users conducted in mid-March – when the pandemic peaked worldwide.
Users were seen increasing their stock market exposure in mid-March – when the pandemic peaked worldwide.
Downside to bargain hunting
But while valuations as indicated by metrics like price-to-earnings and dividend yield have corrected substantially in similar situations in the past, relying on such figures alone in the current scenario may not lead you to the right decisions.
The reasoning for such a logic is pretty simple. Let’s revisit the present scenario when one were to look at the popular stock performance indicator – Price-to-Earnings Ratio (P/E Ratio).
The use of P/E Ratio is purely based on earnings growth of the last 12 months, which is definitely no longer reflective of the reality wherein earnings are bogged down by the devastation caused by the unfolding coronavirus-related economic shocks.
Since the figure turns irrelevant and hence can’t be applied for companies currently stepping into the earnings season, equity investors and analysts will have to start looking at 2021-22 estimated earnings-to-value in company stocks.
Even the P/E Ratio based on forward earnings do not provide an accurate depiction.
The one-year forward earnings growth assumptions are revised by barely knowing the extent the ongoing colossal crisis has had on earnings. For now, only an impact over the next six months has been accrued in.
Matter experts reiterate that investors sticks with the strongest players in their respective sectors based on inherent balance sheet strength.
So, earnings profile for next six months is considered irrelevant. Which is why many matter experts reiterate that investors stick with the strongest players in their respective sectors based on inherent balance sheet strength.
Using a similar understanding, other metrics like dividend yield and price to book value too are considered misleading as there will be many companies that will cut dividends in these uncertain times.
Some tips for bargain hunting
• Gaining knowledge while diversifying
Experts recommend investing only in what you know, as well as trying to maintain a diversified portfolio.
While tempted to look at a stock that may seem attractive to an investor after having fallen 20 per cent, investors should read the relevant news and get a “wider picture” of the company to make sure they are comfortable with the investment.
It can be easy to get sucked into investing, particularly novice investors, simply because prices are so much cheaper than they were last week, but you still need to be happy to own anything you buy — even if you do intend for it to be a short-term investment.
It can be easy to get sucked into investing, particularly novice investors, simply because prices are so much cheaper than they were last week
By monitoring company and stock market announcements, including financial updates or results, one can get a clear inkling as whether it really worth buying the company. If you still feel it is worth it, then go ahead.
• Nailing the non-corona reason for decline
Some still argue that the old investment adage “buy low, sell high” does imply in times like these, which have often proven only in hindsight to have presented great opportunities for investors.
But it is vital to distinguish between companies that have seen their share price fall too far as a result of everything being dragged down in market panic, and those that had sold-off because they faced large headwinds from the coronavirus.
Some still argue that the old investment adage “buy low, sell high” does imply in times like these
What this means is in order to identify undervalued stocks, investors should consider how much the coronavirus crisis will impact the company now and in the future, as well as its financial stability.
So, experts press investors to consider whether a company’s business model puts it in a better position to weather the crisis, or if its prospects are substantially – or even permanently – affected by a downturn.
Red flags include ‘cyclical’ stocks – meaning a business that’s highly affected by the condition of the economy – and firms that accumulate way too much debt.
Investors should therefore make sure changes to their investment portfolio are for the long term and not for a few days. Chopping and changing can mean you quickly rack up lots of trading costs, which will eat into any returns.
Seek ‘value’ over ‘growth’ stocks, or vice-versa?
So in the current scenario, should an investor opt for value-based investing, which refers to the investing strategy that favors stocks trading for low ratios of price/book value, price/earnings, and price/sales, among other similar measures, while betting that it will go high.
Or, in contrast, is it going to be growth-stock investing, which favors stocks that are trading for high such ratios, by betting it will weather a similar sized storm in the long term.
While history sides with value-based investing, in the present scenario it does not.
According to stock market data dating back to 1927 up until 2019, 20 per cent of stocks closest to the value end of the spectrum outperformed the growth-stock quintile by an annualized average of 3.5 percentage points.
Many of the companies that led the market higher in the 1990s were those with few assets and no earnings.
In the first month following the bursting of that bubble, value stocks returned with a vengeance — outperforming growth by more than 13 percentage points.
Value-based investing disappoints with COVID-19?
This contrasts with the performance of stocks that were invested on a value basis over the last two months, with a disappointing performance since the February 19 highs, particularly painful for those who have been betting on the resurgence of value-based investing.
Analysts nonetheless argue that it is still fundamentally justified.
That’s because, by definition, value stocks have high earnings yield and low- or negative growth and as a result, they derive most of their value from the near future. What that means is that they are sensitive to the impact of the pandemic.
Growth stocks should fare better at the end of any crisis.
Let’s say a biotech firm with no revenue should be almost unaffected in the current crisis, with maybe the only problem being a small delay in its drug development timeline, but which may not be that significant if staff can work from home.
So, as touched upon earlier, well-capitalized growth stocks with strong long-term prospects are a safer place to weather the storm.