Naive 20-Year-Old Cracks The Investing Code
I was travelling on the train recently when I bumped into a girlfriend of a friend. 20-year-old Jody was making the one-hour train ride to go to her daily university classes.
About 30 minutes into the journey, we started talking about what I
did for a living. I explained to Jody that I write about the stock market, and have a keen interest in shares.
Jody knew the stock market had been through a tough patch. It had been in the news, and she’d read about how some people had lost fortunes in the great crash of 2008/9. After I explained my simple version of how it all happened — too much debt, too much spending, over-inflated house prices, questionable lending by the banks, over-valued share prices, recession — she asked two simple questions.
1. If people were happy to buy shares a year ago, why aren’t they buying more now prices are more than 20% cheaper?
2. Surely cheaper is better, isn’t it?
They were great questions. One reason people who bought last year but are not buying now is that in early 2008, most of us didn’t know the global economy was about to enter a deep recession. In a recession, profits fall, and although share prices have already fallen, they are not necessarily cheap just because they have fallen by 40%, 50%, 60% or more
A Risk-Averse Nation Of Investors
Back to Jody’s questions. Another reason why people aren’t buying shares today is because we’ve all suddenly become risk averse.
If we are risk averse because we fear for our jobs, and we want to build up a buffer of savings should the dreaded P45 land on our desks, that’s completely understandable.
If we are risk averse because we fear the worst for the global economy, and we expect share prices to fall significantly from here, that too is understandable. That said, we don’t want try to time the market, because as we all know, timing the market is virtually impossible.
But if we are risk averse simply because we’ve lost money, and are fearful of losing more money, we’re a) potentially going to fall for the biggest investing mistake of all time, of buying high and selling low, and/or b) miss out on some compelling long-term bargains.
Cheap Is Good
Jody, in all her naivety, hit the nail on the head. Cheaper is better. Would you rather buy Unilever (LSE: ULVR.L – news) (LSE: ULVR) shares at the 1,927p they traded last year, or at the 1,427p they trade today? How about BHP Billiton (LSE: BLT.L – news) (LSE: BLT)? Would you rather buy them at last year’s 2,166p or today’s 1,297p?
Obviously the investing game has changed between last year and this year. In the case of Unilever, sales growth has slowed as consumers spend less, and trade down to ‘value’ brands. In the case of BHP Billiton, we’ll they’re a victim of the bursting of the resources bubble and the ensuing global recession.
Yet you could argue most of the bad news, including a long recession, is already factored into share prices of companies such as Unilever and BHP Billiton. And when you compare their dividend 4%+ yields with that of base interest rates at 0.5%, shares look even more attractive.
Keep It Simple Stupid
So Jody, in answer to your simple questions, people who bought shares last year should be buying shares this year, and yes, cheaper is better. But as ever with the stock market, there are always other considerations to take into account, such as individual company valuation and competitive advantage, the economy and interest rates.
As an aside, it’s exactly these factors that Maynard Paton, over at our premium stock-picking service Champion Shares, spends his time looking at. Take out a free 30-day trial today at www.fool.co.uk to check out his very latest share recommendations.
But I digress. My one-hour train journey with Jody was enlightening. Stock-market investing need not be complicated. If you ask Jody, she would sum it up as “Buy shares when they are cheap, and sell them when they are expensive.”
Many companies are cheap today. I’m still selectively buying. If Jody had the cash, she’d be buying, too. Her day will come.
By Bruce Jackson
