Wednesday, 17 June 2009

Stock market: opportunity of a lifetime or priced for a depression?

Stock market: opportunity of a lifetime or priced for a depression?

By James Bartholomew
Published: 10:45AM GMT 09 Mar 2009

These are the two messages investors are hearing simultaneously these days: the first is: "Watch out! The recession is getting to look more like a depression. Safety first. Avoid shares and anything with the slightest risk."

The second is: "Shares are ridiculously cheap. This is the opportunity of a lifetime. Do you want to look back at this time and reflect that you funked it? Buy now!"

So investors are pulled one way and then the other. Let us not pretend it is easy. If possible, one wants to have one's cake and eat it – to finesse the problem by having exposure to shares but, at the same time, owning ones that might hold up even if things worsen.

Related Articles
Dividends: Which are safe and which may fall?
'Fixed interest of 6.4pc for the next 10 years. What's the catch?'
'I did my research and bought the shares. A week later they had halved'
Is your building society safe?
Celtic cool on Phil Gartside's two-tier English Premier League plan
Flight to bonds in tougher times

The trouble is, lots of people are trying to do the same, so anything that looks pretty safe gets a much higher rating than companies that could get into trouble.

The safest ones are often in sectors where it will take a lot to destroy demand. People are always going to want to eat, and will probably want to drink, too. We are going for "the bare necessities of life".

Fortunately, the stock market is so low that, even among such safer companies, shares are clearly good value for the long term. It would be easy to make a little portfolio of relatively reliable companies with modest, but perhaps sustainable, dividend yields. It could include Associated British Foods at 622p on a prospective yield of 3.3pc, British Sky Broadcasting at 452p on a yield of 3.9pc and, say, Tesco at 310p on a yield of 3.7pc.

I prefer to go for smaller companies where I believe share prices are cheaper and potential gains bigger. I have been buying back into REA Holdings, which has a palm oil plantation. Palm oil is used, among other things, as a basic foodstuff.

I have also held onto my stake in Staffline, which provides "blue-collar" labour for a variety of industries, but especially food processing. Staffline produced its annual results this week and they were a perfect illustration of how results announcements have changed.

Press releases of results often start with "Highlights". Twelve months ago, companies shone light on their growth and expansion. "Highlights" were full of bold ambition. Now, the greatest boast a company can make is that it is safe and won't be closed. On Tuesday, Staffline announced its "gearing" – borrowing as a proportion of the shareholders' net assets – had fallen from 28pc to 24pc.

In the old days, companies were criticised if they borrowed so little. They were accused of "failing to make full use of their capital base". Now, low borrowing is absolutely the fashion (except for the Government).

Staffline went on to trill about how the cost of its interest payments had tumbled by a quarter and that these payments were covered a wonderful 10 times by profits. The message was "we have been prudent, we are safe and our bankers are happy". The shares rose 15pc.

Many people feel big companies are safer than such small ones and I don't blame anyone wanting to feel safe. But small companies, as a generality, are much cheaper than large ones at the moment. They also have greater scope for growth. And, after Royal Bank of Scotland, surely no one is confident that size guarantees safety.

I don't hold any particular torch for Staffline, but it is a good example of what I see among plenty of small companies. Its share price, as I write, is 27p, a mere 2.5 times the earnings per share last year. That is seriously cheap. Over the long term, a rating of at least four times that would be normal.

A broker forecasts that its profits will fall this year but only by a little. The historic dividend yield is terrific at just over 10pc. Yes, the dividend could be reduced next year but probably not by much.

It does seem like the opportunity of a lifetime and one might be tempted to fill one's boots with the shares of companies like this.

The only thing that holds me back is the echo of the other message: that the economy is sliding down so fast and unpredictably that one should keep at least some cash in reserve.

No comments: